All Squared Up

Square is losing money. Like, mad money.

The mobile payments company is planning to go public, and filed IPO (initial public offering) documents last week, giving people a chance to comb through its financials – and on first glance…it doesn’t look great.

The company competes with other shops like Venmo and Paypal in the money transfer game – which means they will have to up their game if they want to stay competitive.

Let’s dig in a bit further, though. When a company goes through the process of becoming a public company, they have to submit an S1 filing, which contains its basic business and financial information. This is where we’ll find our answers.

In the 6 months ending June 30th 2015, Square pulled in revenues of $560 million. Not only is that an impressive number without any context, but it also represents a 50% increase from the first 6 months of 2014.

Not bad.

Except that for the same time period, Square recorded a net loss of almost $80 million.

Yikes.

If Square were to replicate their first half of the year, then that would mean they pulled in over a billion dollars in revenue and still lost more than $150 million! $150 million is no chump change; for that money you could pay for a private company to send you to the moon…and back.

square

However, before we call it case closed and walk away, let’s dig in further. There’s a metric that’s always included in the S1: the EBITDA.

If you’re familiar with financial statements, you’ll know that the EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization. If you’re not…well, now you know too.

The EBITDA tells us what a company earns less its expenses, excluding super annoying things like taxes or amortization.

Ultimately, the EBITDA allows companies to reflect what they think is the “true” profitability of the company, because it allows for greater discretion as to what’s included in the final calculation than a straight profit-loss number.

You have to be careful, though – because while some items can justifiably be excluded via the EBITDA, others may not necessarily be as justified. You really have to look at everything. With a company that’s going public and looking to raise money, it’s not hard to imagine why it would be in someone’s best interest to dress the numbers up.

Square is removing things like stock-based compensation (an expense that must stand, but as Square argues, does not reflect the true health of their core business). Can you see how it’s a bit of a grey area? Compensation is a responsibility the company holds towards its employees but for a company that is not yet public, stock-based compensation is something that won’t ultimately be realized until AFTER they go public.

There is one notable exclusion. In its EBITDA, Square is taking out all of the costs associated with their Starbucks partnership. In a nutshell, Square loses money on every transaction that takes place at a Starbucks that is using their technology. Square makes money on all other transactions in other businesses it associates with.

What makes one business different from another?  Why is it that Square can exclude one business on the basis that they are losing money with them and make out like their business is doing just fine?

It’s like if you owned a car dealership and had sold one car all month. Not a great month, but if you exclude all the cars you didn’t sell then…hey, you sold 100% of your cars. Great job!

Their reasoning is that the deal with Starbucks ends in Q3 2016 – so again, the numbers don’t fully reflect the health of the main business.

The exclusions allowed Square to shrink their overall loss to $19 million when compared to the $80 million mentioned earlier. When you look at the number for the most recent quarter, Square’s actually reporting a slight profit.

square

Pretty nifty trick, hey?

While it’s true that Square will not be losing money on Starbucks transactions one year from now, they’re still losing money today, right now, right this second. But as with all things, you be the judge. What do you think?

The reality is that while EBITDA is a good metric to look at to evaluate a company’s profitability, it isn’t good at evaluating cash flow. That you have to look at separately, while making sure that a company isn’t trying to hide something with their EBITDA.

So how is their cash flow then?

Square allows a shop owner to accept payments via a mobile phone or credit card and the square reader. In return, they take a cut of the transaction (around 3-4%). As Square reports in their S1, 95% of their revenue comes from payments and it’s been consistently growing for the last few years.

In 2012, they brought in 200 million, which grew to 550 million in 2013 and in 2014 Square brought in a massive $850 million in total revenue. That’s good news. Square is consistently growing the business, even if actually making a profit has so far been beyond them.

So Square’s latest move – filing for an IPO – likely indicates that they are looking for more money to stay afloat as they continue to hemorrhage dollars. It’s a strategy that’s been employed by other companies in the past. Paypal would likely not be where it is now, an $8 billion+ company, were it not for the deep pockets of eBay. The risk is that Square won’t be able to gain enough of a toehold before operations have to be aborted.

They are precipitously balanced and it may be that going public is their Hail Mary pass. It is telling Daniele Morrill, founder of Mattermark, believes that Square could not raise money on the private market at a price it was happy with and therefore is going the public route.

square

 

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