Block Stock: Bitcoin Bloodbath But Gross Profits Matter (NYSE:SQ)

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Joe Raedle

Block, Inc. (NYSE: SQ), formerly known as Square, is a leading Fintech company that has built two product ecosystems, its Square Merchant services and its Cash app. The Company’s Cash App Revenue Has Been Decimated by Bitcoin’s Fall Price and the subsequent “Bitcoin Winter” in trading. However, its gross profit still increased, which is more important. More than 47 million accounts were processed on its Cash app in June, and the company noticed strong retention patterns between accounts that were connected to four or more other accounts. This means that the company has discovered how to improve the true “network effects” of the treasury application ecosystem and thus generate long-term retention.

However, lukewarm forecasts and the coming “recession” have spooked investors, and the stock price has now fallen around 7% in after-hours trading. Given these factors, the stock is inherently undervalued and relative to historical multiples. So, let’s break down its latest earnings report for the juicy details.

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SQ given by Y-Charts

Low revenue, high gross profit

Mixed generated block finance for the second quarter of 2022. Total net income was $4.4 billion, which was actually a 6% decline, primarily due to the continued decline in Bitcoin revenue. Without Bitcoin, net revenue hit $2.62 billion, up a rapid 34% year-over-year. In previous articles on Block, I have talked in detail about the revenue risk of Bitcoin volatility. Now it looks like my thesis is coming to fruition, because ever since the price of Bitcoin fell, most retail investors are hesitant to trade. The good news for Block is that Bitcoin has never been a major profit driver, as the company does not have large margins on Bitcoin transactions. As a result, gross profit actually increased 29% year-over-year and 47% on a three-year CAGR basis.

Gross profit

Gross profit (Block Q222)

Gross Payment Volume (GPV) grew to $52.5 billion in the second quarter of 2022. That’s a 23% year-over-year increase, which was okay, but slower than the previous years. International markets saw GPV rise sharply, increasing it 45% year-over-year, compared to 22% for US markets.

Gross payment volume

Gross Payment Volume (Q2 Revenue Report)

Block of acquisition Buy Now Pay Later (“BPL”) provider Afterpay is now fully integrated and contributed $208 million in revenue and $150 million in gross profit.

Overall transaction-based revenue was $1.48 billion in Q2 2022, up 20% year-over-year as transaction-based gross profit edged up 10% year over year to $600 million. However, Blocks’ subscription and service-based businesses were the main driver of growth, with revenue of $1.09 billion up 60% year-over-year. The segment’s gross profit was $882 million, up a rapid 56% year-over-year.

Square Merchant Products

Square Merchant Products (Investor Day Presentation)

The merchant side of the Blocks business, “Square,” generated $1.73 billion in revenue, up a rapid 32% year-over-year. Gross profit also increased to $755 million, up 29% year-over-year. This growth was bolstered by strong subscription and services revenue, up 110% year-over-year to $318 million. However, because “Square” derives the majority of its merchant revenue from transactions, that still accounts for the majority of its $1.36 billion, which is up 22% year-over-year. Interestingly, Square saw a lower percentage of credit card transactions, which began to “normalize” from pre-pandemic levels.

Block gross profit

Block gross profit (Q2 revenue report)

Block is executing its international expansion plans well. The company launched 44 products in international markets in 2022, aiming to improve “product parity” across regions. For example, the Bloc launched Square register in Ireland and France, in addition to square appointments in Japan and instant bank transfers to enrich its Australian offer. These initiatives pushed Square’s percentage of gross profit from outside the United States to 13%, up from 8% in the prior quarter.

International Square Gross Profit

Square International Gross Profit (Q2 earnings)

Squares software subscriptions delivered solid 10% year-over-year growth to $48 million, while its hardware revenue (what the company makes from the sale of its point-of-sale terminals ) rose 10% year-over-year to $48 million. This was specifically due to the strong growth of products from the “Square Register” and the “Square Terminal”.

Square Loans continued to grow strongly, with loan originations jumping 30% year-over-year to 122,000. This tranche also benefited $9 million in Paycheck Protection Program (PPP) loan support during the quarter.

Overall profit and loss

Combining all business segments, Square generated a net loss of $208 million. That may not sound great, but it’s worth bearing in mind that $57 million of that was related to a balance sheet adjustment of $57 million in acquired intangibles and $17 million in capital expenditures. integration. These were most likely related to the After-payment acquisition. In addition, $36 million of this amount was related to an “impairment” of Bitcoin. Therefore, if we assume the prior items were “one-time” expenses and exclude those items, Blocks’ net loss was $98 million.

Net revenue loss

Net Revenue Loss (Q2 Earnings Report)

Adjusted Block EBITDA was $187 million in Q2/22, down from the $360 million generated in the second quarter of 2021. But, again, this was primarily due to higher operating expenses resulting from the acquisition of Afterpay and integrations.

Block EBIDTA

Block EBIDTA (Q2 earnings report)

Block has a strong balance sheet with $6.2 billion in cash, cash equivalents, restricted cash and marketable debt, in addition to $600 million available on their revolving credit facility. Its total debt is quite high at ~$5B, but I would say that is very manageable given that the majority (~$4B) is long-term debt.

Looking ahead, management produced a lukewarm outlook for July. They forecast the Gross Purchase Volume (GPV) growth rate to increase by 18% year-over-year, which is slower than the rate of the previous quarter.

Non-GAAP operating expenses are expected to increase by approximately $75 million compared to the second quarter of 2022. This includes product development costs, sales and marketing, general and administrative expenses, as well as losses on transactions, loans and trade receivables. So, I would imagine that this muted guidance is why the stock was actually down about 6% in after-hours trading.

Advanced block assessment

In order to value Block, I incorporated the latest financial data into my advanced valuation model which uses the discounted cash flow (“DCF”) valuation method. I’ve optimistically forecast revenue to grow 20% over the next 2-5 years as the business continues to expand internationally and grow “high end” targeting larger merchants , such as with the 10-year partnership with SoFi Stadium. announcement previously.

Valuation of block stocks

Block Stock Valuation (created by author Ben at Motivation 2 Invest)

Additionally, I projected a 17% pre-tax operating profit margin generated over the next 7 years as the company improves its marketing effectiveness and its “one-time expenses” begin to become less common.

Valuation of block stocks 2

Block Stock Valuation 2 (created by author Ben of Motivation 2 Invest)

Given these factors, I get a fair value for Block Stock of $110/share. The stock is currently trading at $89/share, so it is about 20% undervalued. As an additional data point, Block is trading at a price-to-sales ratio = 2.6, which is around 66% cheaper than historical levels.

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SQ PS report given by Y-Charts

Risks

Slowdown in consumer spending/recession

As mentioned in my previous posts, high inflation tight the consumer with higher food costs and utility bills. The Fed raises interest rates to fight inflation. However, this squeezes the consumer with higher debt service costs. With less excess income, consumers are likely to spend less. Block calculates its revenue based on trading volume, less volume equals less revenue. Although I think this is only a temporary problem (until inflation goes down), it is still a risk.

Final Thoughts

Block is a great company that has built two diverse product ecosystems with its merchant services and treasury app. The “Bitcoin Winter” has impacted Square’s revenue, and continued volatility is expected going forward. Despite this, Block’s gross margin is still growing strongly and they are executing their international expansion and upscaling strategy well. So, this stock could be a great long-term investment for the future of fintech. However, I would watch the technicals and wait for the stock to fall and reach support before entering.

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