Why Acquirers Should Be Afraid of Square

If you want some good old-fashioned negativity, just Google the words “Square and unicorn,” and you’ll find an infinite supply of articles spelling out how Square is a symbol of all things evil in the business world and how it’s a classic case of economic-stimulus-inspired Silicon Valley overindulgence that’s about ready to collapse (how about this image from CNN/Money?). It’s utter nonsense. Square is a standout company that is fundamentally changing merchant acquiring for good. Here are four reasons why.

1. Square’s Approach Is Unique

I often hear that Square has many competitors because the mobile card-reading dongle is ubiquitous. But the dongle isn’t the source of Square’s advantage, and it never has been. Square is a unique company from top to bottom. While the industry copycats have all dropped dongles and mobile apps into their existing distribution channels, Square has built its entire business around enabling frictionless payment acceptance. Frictionless acceptance means that when buyers have a need, they can go from need identification to product use in just a few seconds. Square did, and continues to do, everything in its power to make buying payment solutions completely frictionless. That includes building a global brand; investing heavily in awareness-based sales and marketing efforts through advertising; forgoing traditional, sales-intensive distribution channels; adopting the payment facilitator model; re-inventing application and underwriting processes; re-inventing customer servicing processes; designing products and pricing for absolute simplicity; automatically covering up to $250 in monthly chargebacks; offering proprietary hardware through multiple online and retail channels; embedding encryption and tokenization at no extra cost; and deploying all software via the cloud to maximize scalability. The source of Square’s advantage isn’t any one of these points but rather the summation of these points and several others into the fact that no one else has built an entire business model around eliminating friction in proximity payment acceptance.

This strategy has allowed it to acquire approximately 2.1 million customers in just a few years, a scale that would otherwise be impossible even if Square had been able to hire every single acquiring salesperson in the country. Square’s awareness-based strategy enables buy-ready merchants to seek out Square, so Square doesn’t have to hire an army to seek out buy-ready merchants. Square doesn’t need the sales teams that traditional acquirers need. Frictionless means that when buyers have needs they know where to go, and they can fulfill their needs quickly and easily. It doesn’t mean having an army of people making outbound calls, which is only needed for high-friction sales where the buyer needs lots of convincing or where buying isn’t that easy.

2. Its Growth Rates Are Exceptional

Square’s adjusted revenue grew 137% in 2013, 73% in 2014 and 64% in 2015, an average rate of 91%. Before you start pointing out that this looks like a declining rate of growth, consider that in dollar terms Square added $93 million in revenue in 2013, added $116 million in 2014 and $176 million in 2015. While on a percentage basis Square does have slowing growth, that slowing is entirely due to a rapidly growing denominator, not due to a shrinking numerator. A continuance of this trend will put Square’s 2016 revenue at nearly $700 million, which makes Square’s current guidance of $600 to $620 million seem conservative (Figure 1).

Figure 1: Growth in Annual Adjusted Revenue, 2012-2015


Source: AZPG analysis of data provided by Square SEC filings

Compare that to the rest of the industry, which, according to the Nilson Report, saw transaction volume increase by 7.8% in 2015.

3.  Its Market Potential Is Even Greater.

In addition to continuing to grow within its current core competencies, Square has the opportunity to expand in at least three different directions:

  1. Moving up-market to serve larger merchants.
  2. Adding new products and services.
  3. Global expansion.

Square has shown definitive progress in all three.

A. Moving Up-Market

Square is a dominant force in the micro-merchant segment (those that process less than $100,000 per year in transaction volume). In fact, the average Square seller still processes only about $16,500 annually. However, by isolating just the portion of Square’s portfolio that processes in excess of $100,000 annually, we can get a good view of how effectively Square is competing with traditional merchant acquirers in the larger merchant segments.

In 2012, Square’s $100K-plus segment processed $1.2 billion, followed by $4 billion in 2013, $8.1 billion in 2014 and $13.9 billion in 2015. A continuance of this trend projects to $22 billion in 2016 (Figure 2).

Figure 2: Gross Processing Volume of Square’s Largest Merchants


Source: AZPG analysis of data provided by Square SEC filings

This equates to an average CAGR of 106% annually, which is faster than Square’s overall growth rate. Not only is Square far exceeding the industry growth overall, but it is also beating the rest of the industry within its primary areas of specialization by an 8x multiple. By the end of 2016, Square’s $100K-plus segment alone will make Square the United States’ 21st ranked merchant acquirer, up from its 2012 numbers that would place it at #63. By continuing to grab market share from its competitors, Square has billions in additional growth opportunities, and it has already proven that it can win.

B. Adding New Products and Services

Since day one, Square has been working to expand around its core business model of delivering frictionless payment acceptance to also make consumer payments frictionless (the efforts on Square Wallet), to make ordering meals frictionless (Square Order and Caviar), to make business capital acquisition frictionless (Square Capital and the Square lending), to make marketing frictionless (Square Market, Square Customer Engagement), and to make the acquisition of other services such as invoicing, gifting, payroll, and appointment setting all frictionless too. Square continues to spend enormous amounts on new product development ($200 million in 2015, or 44% of adjusted revenue) in order to expand its core beyond payments. It’s starting to gain traction here as well. Revenue from nonpayment-related services went from zero to $58 million in the last two years. The total market potential for these services far exceeds that of the payments industry alone, and Square’s cloud-based infrastructure, integration with the point of sale, access to inventory data, ability to integrate with third parties and customer base of millions put it in an ideal position to pursue a multitude of new opportunities that far outstrip those of payment specialists.

C. Global Expansion

Square currently offers its services in only the United States, Canada and Japan, markets that encompass less than one-third of the total card-accepting merchant population. Square’s cloud-based infrastructure and awareness-based sales and marketing strategies mean that it can expand into new markets a rate that far exceeds that of competitors. In the global marketplace, it can tap opportunities that are at least three times larger than its current markets.

4. It’s Already Self-Sustaining.

In 2015, Square spent $200 million on new product development and an additional $146 million on sales and marketing efforts. It incurred an operating loss of $175 million, meaning that through reduced expenditures on growth, Square could have easily been profitable in 2015. However, it’s also clear that while generally accepted accounting principles (GAAP) consider product development, sales, and marketing to be expenses, Square’s management considers them to be investments in future earnings, and it is therefore willing to spend aggressively on them at the expense of profitability. Profitability is therefore not a good measure of company sustainability. We must revert to cash flow. Square’s cash flow from operations turned positive in 2015, providing $27.6 million in new, spendable cash (Figure 3).

Figure 3: Square’s Cash Flow from Operations


Source: Square SEC filings

Management guidance suggests that Square will become profitable in 2016, but the company has already turned the corner to ongoing sustainability at current spending levels regardless of profitability. The fact is that Square generated $27.6 million in positive cash flow from operations after investing hundreds of millions on discretionary future growth initiatives. It will continue to do this in order to expand on its already stellar growth, regardless of impacts on profitability.

Square is a unique, aggressively managed, high-profile, high-growth company that takes on high-risk customers. As a result, its share price will fluctuate, and the press will not miss opportunities to criticize the company during downswings or trumpet its successes during upswings, but don’t let share price fluctuations and press sensationalism bias your view. Square is a competitor that you must contend with and learn from.


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