(March 24th, 2023)
By (Ottavio De Noia, Equity Research)
Edited by (Ascanio Cicogna, Head of Research)
How inconsiderate policies allowed insiders to cash out more than $1bn
Jack Dorsey’s Block, Inc. has been severely hit by the recent news coming from Hindenburg Research, a well-known investment research company focusing on short selling strategies and stock manipulation who recently sunk the Indian enterprise Adani Group’s stock, plunged at -49,81% in the last 2 months, right after the publishing of a short-report. Eyes are now all focused on Block, Inc. opening today’s market with a sound -16,1% for an opening price of $60,00.
Block: a healthy business model?
The business Block, Inc. runs is mainly built upon five services, namely: Square, a platform which allows businesses to accept credit card payments and use tablet computers as registers, Tidal, a music streaming platform, Weebly, a web hosting platform, Afterpay, and the infamous Cash App.
The latest, Cash App, should have formerly been a platform allowing individuals, recognized in the app through a “$cashtag”, to receive and send money peer-to-peer, in a way to empower the underrepresented groups of people, the so called “underbanked”. However, after two years of research, Hindenburg is now revealing the reality behind this seemingly efficient and safe project.
Hindenburg Research’s whole report states the inefficiency of Block, Inc. and specifically the facilitation of fraud against consumers and governments, the will to avoid pre-existing regulations while dressing up the whole business as a revolutionary paying system which misled final consumers with enhanced metrics. They indeed overstated the number of active users, among whom around 40-70% were fake accounts or were involved in fraud. Additionally, Block, Inc. has understated its customer acquisition cost to facilitate some income statement’s adjustments. In fact, the app has been rapidly turned into a real heaven for scammers and criminals due to the lack of regulation, who according to Hindenburg use the platform for sex and drug trafficking, avoiding any kind of repercussion since, when dealing with illegal acts, Block simply blacklistes the accounts without banning them, allowing scammers to easily turn around and create a new account, trapping unaware consumers in the hands of the part of society which Block claims to represent and help, which in reality is the one harming loyal consumers acting in good faith.
In addition, to prove the reality of their research, Hindenburg successfully created and received a Cash Card connected to the Cash App account under the fake name of “Donald Trump”, thus implying that the whole expansionary projects of Block disregards money laundering regulations (AML) as well as privacy policies and a sustainable growth project, caring only about the number of “active” accounts, namely the ones that have completed at least one transaction.
The surprisingly frictionless payment system also allowed people during the Covid-19 pandemic to receive government payments in a time when Covid-relief policies were implemented, with the possibility of getting cash on the app without owning a bank account, causing a process of fraudulent conduct against states, with Arizona and Washington cumulatively asking for more than $700 million back from payment processors. How was this possible? The app made it easy for people to receive multiple payments on multiple fake accounts from different states across America, due to the ineffective address verification.
Figure 1: Total Revenue/ Net income
Source: Yahoo Finance, Block, Inc. (SQ)
Insight into Block’s financials
Revenue in 2022 declined by 1% (see Figure 1) with respect to the previous year, and with $540,7 million in losses on a GAAP basis, the stock, primarily dependent on Cash App, is bound to stagnate, with analysts expecting a further $208m loss in 2023, with the management team warning investors about the potential losses in their 2022 annual report:
“We have generated significant net losses in the past, and we intend to continue to invest in our business. Thus, we may not be able to maintain profitability.”
Despite those signs of weakening, the stock is currently trading at a forward P/E ratio of 40x, thus being trading as a growth stock, and with an EV/EBITDA of -231,19x due to the negative EBITDA, with his peer PayPal trading at a 16.6x EV/EBITDA.
Moreover, to “hide” those significant losses, they exploited non-GAAP adjustments to report growth, transforming $540 million losses into $613 non-GAAP profit by adjusting out costs. (see Figure 2)
Figure 2: Net income GAAP/ Non-GAAP
Source: Hindenburg Research short-report, Block, Inc. (SQ)
Conclusion
Even with a real effort to bring the situation under control, the entire business model of Block, Inc. and specifically of Cash App, should be entirely rethought, with the implementation of safer regulations, a vast and widespread control over privacy and anti-fraud policies, and a major control of the users, with instant bans for users who don’t respect the rules of conduct. Will the efforts of the managing team be enough to re-educate and repopulate the platform once it gets freed by criminals and scammers? Will the platform be preferred and generate a positive cash flow in an environment dominated by the rivalry of PayPal and other similar services? In our view, despite the trial to reverse the negative trend on the stock, it is going to suffer the repercussions of an unhealthy business model and lack of control, thus leading to a further decline in the share price.
Potential Investment Opportunity
Looking for interesting investment opportunities and given the unfavourable present financial outlook, due to the contractionary monetary policy being carried out by central banks worldwide, together with the disrupted supply chain, the whole Block, Inc. business has several different reasons to be believed as to experience a decline in prices, leading us to a final short recommendation that could hopefully turn into a nice investment tip.
Citations:
Hindenburg Research, Block: How inflated user metrics and "frictionless" fraud facilitation enabled insiders to cash out over $1 billion. Hindenburg Research. (2023, March 26). Retrieved March 27, 2023, from https://hindenburgresearch.com/block/
Yahoo! (2023, March 27). Block, Inc. (SQ) income statement. Yahoo! Finance. Retrieved March 27, 2023, from https://finance.yahoo.com/quote/SQ/financials?p=SQ
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