I put Block (NYSE:SQ) on the Stock In Isolation list for subscribers to my marketplace Potential Multibaggers months ago, which means I don’t add to the stake. This is because I anticipated a significant impairment from the Afterpay transaction. The firm was acquired in an all-stock transaction. Given how far Block’s shares have fallen, it is inescapable that the corporation does not account for a significant impairment.
This is not a major issue; it indicates that conditions have changed. Moreover, it does not affect cash or anything else other than accounting. Still, algorithms and short-term investors pick it up and can penalize the company badly.
The transaction is still referred to as the $29B deal. Still, because Square paid with its shares, which fell dramatically (much like Afterpay’s), the price was significantly lower. The $29 billion figure is based on Block’s stock’s value on the announcement of the acquisition. Afterpay stockholders received 0.375 Square shares for every Afterpay share they owned. With around 290 million shares outstanding and the purchase concluding on January 31, the valuation was just around $13 billion, based on Block’s stock price of roughly $122. This is because the number of shares, rather than the price, was predetermined.
The Q2 2022 results
The firm reported sales of $4.41B for the second quarter of 2022, down 5.8% yearly but above expectations by $80M. Don’t be too concerned about the income decrease year over year. The firm is required to record revenue that includes Bitcoin. It requested an exemption from the SEC at the time since Bitcoin is not a significant source of income for the firm. Square (at the time) intended to include only the margin it took on Bitcoin (which is extremely little) in revenue. Still, the SEC refused to grant the exemption. Furthermore, Block has bought Afterpay, making comparison much more difficult.
As a result, the following phrase from the Q2 2022 shareholder letter describes the company’s revenue much more clearly: “Excluding bitcoin and our BNPL platform, Cash App revenue was $732 million, up 21% year over year and 76% on a three-year CAGR basis.” This was good, in my opinion, against extremely difficult competition. But, of course, this is only Cash App’s side, not Square’s. In other terms, BNPL stands for buy-now-pay-later or Afterpay.
The non-GAAP EPS came in at $0.18, which was $0.02 more than the expectation. In other words, another beat. The GAAP operating loss was -$208M. A significant portion of that was due to the acquisition of Afterpay. If you buy such a firm, you must deduct the value of the intellectual property. This, together with further integration expenses and the impact of Bitcoin on Block’s financial sheet, immediately cuts the loss in half. The remainder is in stock-based compensation, much of which is related to the purchase and is thus not long-term. However, you could expect operational costs to be relatively high in the coming quarters.
Square (Block’s business payments and services division) had a gross profit of $755 million, up 29%, but Afterpay had a role. It would have been +16% YoY if not for the BNPL platform. Without Afterpay, Cash App’s gross profit was $705 million, up 29% or 15% yearly. Maybe not earth-shattering, but solid on really difficult comps. Bottom line: overlook the 5.8% revenue loss in the headline figures.
Afterpay is now completely integrated and delivered $208 million in sales and $150 million in gross profit, which I consider impressive. AfterPay ‘only’ cost roughly $14 billion instead of the anticipated $28 billion since Block paid for the purchase with a set number of shares. Both equities were down significantly before the deal was completed. Of course, this helps with the magnitude of the limitations. With $150M in gross profit, Block paid around 23 times annualized gross earnings for Afterpay. It’s not inexpensive, but it’s still developing quickly.
Block’s trailing twelve-month gross profit now exceeds $5 billion.
Block does not give any actual direction. Instead, the company discusses July trends. Because revenue is such an uncertain statistic for Block, the corporation utilizes gross profit.
It predicts a 35% increase in gross profit or a 22% increase without Afterpay. The majority of that comes from the Cash App segment. This is predicted to increase its gross profit in July by 32%, excluding Afterpay.
The Square (sellers) environment slows overall firm development, which is not surprising given that it has traditionally developed slowly. Nevertheless, excluding Afterpay, its gross profits increased by 14% year on year, and its GPV (gross payment volume) is forecast to increase by 18% year on year. I believe we can also see macroeconomic headwinds here, as we can in many other organizations, since Square grows quicker than this. I’ve said it before: if you have to pay an arm and a leg for electricity and groceries, you spend less on frivolous items.
Block is reversing its trajectory, but it is still early in the voyage. Afterpay may be a far better acquisition than many anticipated, given it is not merely BNPL, which many regards as a feature rather than a platform. In addition, Afterpay has a thriving vendor environment thanks to its 144,000+ clients. If those notice that Cash App users may identify them, they can target them with advertising, potentially bringing in a new revenue source for Block.
A lot of water will have to flow under the bridge before this becomes a reality, but because of the potential and the extremely fair, if not cheap, value, I’m happy to add to my Block position again. That doesn’t imply I’ll swallow up large amounts of the stock. Instead, I’ll gradually improve my position by adding intervals. I’d also like to see the firm grow on the proper path.
The idea is convincing; let us hope the implementation is as so.
Meanwhile, continue to grow!
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