If you just looked at the stock market’s reaction to the earnings report from Square Inc. (NYSE: SQ) it might seem like everything is just perfect inside the company. After all, Square’s shares jumped more than 10% and even briefly hit both an all-time high.
There may be more to this story than meets the eye. For better or worse, Wall Street seems to have interlocked the success of Twitter Inc. (NYSE: TWTR) and Square due to the dual CEO role of Jack Dorsey. With all the problems at Twitter and all the growth at Square, maybe it’s time that investors press for Dorsey to focus on just one of these companies.
Dorsey is listed as the chairman, chief executive officer and president of Square. He is listed as the chief executive officer and is a director (but not chairman) of Twitter. Dorsey is a co-founder of both companies.
The stock jump in Square was based on it beating earnings estimates, even as revenues came in just shy of the expectations. The payment processing company actually reported a loss at $0.04 per share. Revenue was up 21% at $451.9 million in the quarter. The consensus estimates were closer to −$0.09 per share and $453 million in revenues. For all of 2016, Square’s loss narrowed to $171.6 million for a −$0.50 per share, and revenue was $1.71 billion.
Square also gave guidance for the first quarter of 2017 revenues of $440 million to $452 million. And for the year, the adjusted earnings per share were forecast in a range of $0.15 to $0.19 on revenues ranging from $2.09 billion to $2.15 billion. On a traditional price-to-earnings (P/E) basis, this would make Square’s valuations look excessive. The company’s own notes on the guidance said:
Our 2017 guidance reflects plans to continue investing in scaling our business, balanced by our ongoing commitment to margin expansion. As a reminder, our business is subject to certain seasonal trends. Historically, the first quarter is our slowest in terms of sequential growth of transactionbased revenue. Additionally, we do not expect to see Starbucks transaction-based revenue going forward, which will have a negative impact on year-over-year growth in total net revenue in 2017. Lastly, hardware revenue in the first quarter of 2016 was elevated due to the fulfillment of the majority of pre-orders for our contactless and chip reader during the period. As a result, year-over-year hardware revenue growth for the first quarter and full year of 2017 will be more moderate relative to prior periods.
The company’s operating expenses were up 15% to $181 million in the fourth quarter, but the good news here is that this was a 1% decline on a sequential basis. Square further said that its non-GAAP operating expenses were up 17% year over year — at 72% of adjusted revenue in the fourth quarter of 2016 (versus 88% in the fourth quarter of 2015).
One issue likely to be a focal point was that Square’s gross payment volume for the fourth quarter was $13.7 billion, up 34% from a year ago. The letter to shareholders said:
Sustained GPV growth is a result of our ability to efficiently add new sellers to Square and provide them with the tools they need to grow. We saw strong growth across our products, with revenue growth driven by both transaction-based and subscription and services-based monetization efforts. We maintained a payback period of 4 to 5 quarters for our seller acquisition costs and a positive dollar-based retention rate, which together underscore our ability to grow this revenue profitably. Additionally, we increased operating efficiency and continued to make improvements in transaction losses. We are carrying this momentum into 2017 by thoughtfully balancing margin expansion and our investments in growth.
One interesting point was seen in the growth of Square’s cash balances. The company ended 2016 with $539 million in cash and equivalents, up from $461 million at the end of 2015. But here was how it was described:
The increase in our cash balances was driven by positive Adjusted EBITDA and proceeds from employee stock option exercises. Separately, we have reclassified amounts related to money customers keep in Square Cash as “customer funds.”
Analysts liked Square’s report, with some of the analyst calls seen as follows:
- BTIG raised Square to Buy from Neutral with a $20 price target.
- Credit Suisse reiterated its Outperform rating and raised its target price to $17 from $15.
- JPMorgan reiterated its Overweight rating and raised its target to $16 from $15.
- Mizuho reiterated its Buy rating and raised its target from $16 to $19.
- Goldman Sachs reiterated its Buy rating and raised its target from $15 to $17.
- Morgan Stanley maintained its Equal Weight rating and the price target was raised to $14.
The take of Barron’s was quite bullish as well: “Square Hits All the Right Angles Again,” noting that the payment-processing player appears to be getting merchants to pay for more of its profitable products.
Square is a company that still has been losing money at a time when Wall Street needs to start evaluating the quality of earnings at high-growth companies. That issue of losing money is expected to change over time, but Thomson Reuters expects a −$0.28 per share report in 2017 and −$0.11 in 2018. The consensus revenue estimates are $2.13 billion for 2017, $2.67 billion in 2018 and $3.21 billion in 2019.
The company’s guidance was reason for a cheer, but there are still a lot of mixed points in the report. What is a head-scratcher is that Wall Street is still endorsing a company that has lost money and is not expected to have any massive profits right around the corner.
Square shares were last seen up 12.6% at $16.94 with a five-times volume spike of 20 million shares just an hour after the opening bell.
Twitter shares were trading at $16.05, in a 52-week range of $13.73 to $25.25. Its consensus analyst price target is $14.25.
At the start of 2017, the investor verdict is that Square is a better place to be than Twitter. Growth opportunities now seem easier for Square than Twitter as well. At some point, perhaps later in 2017, investors may smarten up and make more vocal demands that Dorsey needs to spend 90% of his work time at one of these two companies — even if he remains on the board and in an advisory role at the other.