SQ Deep Dive 1

MBI Deep Dives | September 2021
Square: The quest for an inclusive financial ecosystem

Disclosure: I am long shares of SQ
In 2012, Jack Dorsey, co-founder of Square, gave a talk to the employees at Square. He
discussed the elegance of the Golden Gate Bridge and how design is at the heart of what he
builds: “Design is not just visual, design is efficiency. Design is making something simple. Design
is epic. Design is making it easy for a user to get from point A to point B.”
In the following year, Dorsey expanded further on his Golden Gate Bridge analogy in another talk
at Stanford:
"It (the bridge) has enabled generations of end-users to get from point A to point B. They’re
thinking about point B so much that the bridge just completely disappears…The goal is to make
products and services that are just so intuitive that they simply just disappear into people's lives.”
What started as an elegant white, square shaped dongle for small merchants to accept payments
from customers has today become ~$120 Bn market cap company in just a little more than a
decade. While SQ’s products are yet to assimilate into our daily lives to the extent that it
“disappears” into the background, that is the dream Dorsey is still chasing. Even Jamie Dimon,
CEO of JP Morgan, not only praised how Square capitalized on the white space left out by big
banks but also cautioned how JP Morgan should be “scared s***less” by the fintech threat.
I would like to acknowledge my gratitude to “BlueToothDDS” who was kind enough to discuss SQ
with me and teach me some key aspects of the payments industry through long text messages
on twitter. Without his/her pedagogical session, it would have been considerably more difficult for
me to understand all the nuances related to payments and SQ.
Here’s the outline for this deep dive. Please note that Section 1-4 primarily discuss the narrative
to understand SQ’s business and section 5 ties the narrative and the risks to the numbers:
Section 1 The Seller Ecosystem: This section includes the background story of SQ, early
competition from Amazon and how SQ survived, SQ’s products for sellers, and the size of the
opportunity.
Section 2 The Cash App: I discussed how Cash App was started, current use cases, revenue
streams, competitive dynamics, and some of the blind spots of Cash App.
Section 3 Afterpay: A quasi-marketplace masquerading as BNPL: I elaborated on three
questions in this section: a) How does BNPL/APT work? b) What is the competitive environment
in BNPL? c) How does APT acquisition make sense in SQ’s long-term ambition?
Section 4 Regulatory arbitrage and potential headwind: I explained the Durbin amendment
and why SQ and other fintech may face potential regulatory headwind in the future.
Section 5 Valuation and model assumptions: Implied expectations in the current stock price
was discussed, tying the narrative discussed in earlier sections to the model assumptions.
Section 6 Management and incentives: I took closer look at Jack Dorsey and mentioned my
opinion on him.
Section 7 Final words: Concluding remarks on SQ, and a very brief discussion on my overall
portfolio.
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Section 1: The Seller Ecosystem

In 2008, Jack Dorsey was ousted from the CEO role of Twitter. Evan Williams, one of the co-
founders of Twitter allegedly told Dorsey, “You can either be a dressmaker or the CEO of Twitter.
You can’t be both.” The legend has it that Dorsey used to leave early from work to attend fashion
design and yoga classes. Although he remained Chairman of the board, Dorsey went back to St
Louis, his hometown, where he reconnected with his first boss, Jim McKelvey, the co-founder of
Square. McKelvey used to be a regular at Dorsey’s mother’s coffee shop and he hired Dorsey for
work when he was still a teenager.
Once they reconnected, Dorsey and McKelvey wanted to work together even though they did not
have any concrete idea what exactly they wanted to do together. McKelvey was a glass artist and
one day he was unable to sell one of his $2,000 glass faucets because he could not accept credit
cards. Based on his personal experience, McKelvey almost had a Eureka moment and wanted to
solve this problem with Dorsey.
Not only even the cheapest credit card reader back in 2009 cost ~$950 but also was the size of
a shoe that was clunky and far from intuitive. Small merchants were paying ~4% for their credit
card services. I found the following chart quite revealing in terms of lopsided revenue contribution
and payment volume of small to mid-sized businesses as opposed to large and mega businesses
from this blog:
“This chart below from the First Annapolls consulting analysis shows that the Mega Businesses
pay 0.03c per transaction ($0.5B / $1,562B) vs small businesses that are paying $1.02c per
transaction ($3.6B / $350B). In summary small businesses are paying 34X more than mega
businesses and in aggregate they are producing ~50% of the entire card industries revenue.” (I
could not find the original source which is perhaps behind paywall)
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Once Dorsey and McKelvey understood the size of the problem, they devised a solution in the
form of a small, square-shaped white card readers that can be plugged into the headphone jacks
of smartphones. The design was so elegant that it appeared in Museum of Modern Art. Instead
of $950, Square’s card readers cost 97 cents. Merchants weren’t paying 4% to accept credit card
payments; it was just 2.75%.
As you can imagine, when a museum worthy product is competing against a shoe-sized product
and yet decides to charge low prices, the winner was almost written the moment the race started.
Square did not have to promote the product as everything about the product itself was promotion.
Square grew 10% every week for two years. This is remarkable because there were no network
effects at play. The product was that much better than the existing products. Another important
driver for the rise of SQ in early days was explained to me by “BlueToothDDS”:
“SQ was able to carve out its niche with micro merchants in the early days— which is that it
received support (and financial investment) from Visa in 2011 which enabled more streamlined
merchant onboarding than traditional SMB merchant acquirers. SQ was one of the first “payment
facilitators” (payfac) allowed by V/MA. Similar to PYPL which did this online, by operating as a
payfac, it was able to very easily onboard new merchants (acting as master merchant and taking
on the risk of each sub merchant onboarded). This was significantly different vs the traditional
model where merchants needed to apply and be “underwritten” by acquirers which could take
weeks/months and many small/micro merchants with no operating history (think food trucks or
yoga instructors) would have never been underwritten. Operating as a payfac enabled SQ to offer
simple pricing (2.75% flat fee) vs the more convoluted structures previously offered to SMBs. A
good piece to understand this dynamic in more detail can be found here.”
However, this long honeymoon almost ended abruptly when Amazon showed up in 2014. Like
Square, they gave away their card reader for free, but they wanted to grab the small merchant
segment with a teaser rate of 1.75% which would later increase to 2.5%. As McKelvey puts in his
book “The Innovation Stack”, “Jeff Bezos delivered a severed horse head via free two-day
shipping”. Although the mood was understandably quite grim at Square looking at this competition
from Amazon, they decided to do nothing about it i.e. they did not follow Amazon by decreasing
price.
Before I discuss what saved Square, I want to first explain how a $100 transaction works through
the payment value chain. While the below two images are self-explanatory, I want to emphasize
that this is an illustrative example, and the actual breakdown varies based on various factors. In
any case, a big takeaway from this breakdown should be that Amazon was probably losing money
on each transaction when they launched with 1.75% and the only way they would maintain such
promotional rate if they gain scale quickly and the unit economics of the cohort improved
materially after the teaser rate expires.
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Source: Clearly Payments

Amazon decided to pack bags just after a year in this market and sent Square’s card readers to
all its merchants. If you remember from my deep dive on Shopify, Amazon did the same when
they closed their e-commerce platform Webstore and referred Shopify to its merchants. Perhaps
investing just on companies against which Amazon failed to compete would lead to very
compelling return for investors. (Note: Last week, AMZN announced to enter POS market again,
but since they did not disclose much, it is hard to assess why they decided to re-enter and whether
AMZN can be successful.)
But why did small merchants not sign up for Amazon’s solutions? The reason perhaps was Square
became more than just a card reader that accepts payments at POS. Marc Rubinstein in his
excellent post “Hip to be Square” mentioned why it was difficult to compete against Square:
“Because it operated as a single integrated system encompassing hardware, software and
payment processing, it was able to add new services that entrenched its position with customers.
It added services like working capital, invoicing and payroll, all to help merchants run and grow
their businesses.”
McKelvey alluded to the same in his book, "Innovation stacked upon innovation stacked upon
innovation gives you this weird thing where you end up with a market all to yourself. It's really
hard to unseat a company that has all those innovations."
These innovation stacks led Square to launch multiple stacks of products for its sellers. Square
segments its revenue from seller segment in three categories: transaction-based, subscription
and services, and hardware revenue. For the sake of brevity, I have primarily mentioned pricing
for each of these products, but I encourage readers to click the associated product links to
familiarize yourself with the suit of products.
Product Pricing/features Transaction- Subscription Hardware

based /services
Square Point of Sale 2.65%+10c ✓
Square Appointments Free for one staff, for 2-5 staff: ✓
$60/month, 6-10 staff:
$110/month, custom pricing for
more than 10 staff
Square for Retail $79/month/location. Processing ✓ ✓
rates: 2.6%+10c
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Square for $60/month/location ✓ ✓

Restaurants +$40/month/additional service.
Processing rates 2.65%. Custom
processing rate available if sales
exceed $250k.
Square Online 2.9% + 30c ✓
Square Online 2.9% + 30c ✓
Checkout
Square Invoices 2.9% + 30c ✓
Square Team $45/month/location for Plus plan. ✓
Management
Square Hardware Square Terminal: $299, Stand: ✓
$199, Reader for contactless and
chip: $59, Reader for magstripe:
$10
Square Card Instant access to sales made on ✓
Square PoS.
Square Instant 1.5% ✓
Transfer
Square Capital Fixed “fees” ranging from ~10- ✓
15% of the loan depending on
various factors
On its investor day last year, Square estimated its current TAM in seller segment to be $85B+ in
the US. When we include the international opportunity, TAM increases to $100B+. Let me expand
on these numbers.
Of the $85B+ TAM, SQ identifies transaction profit (not revenue) to be $39B opportunity in the
US. SQ estimated this TAM by citing the total consumer card payment volume multiplied by SQ’s
average transaction margin as a percentage of GPV which is ~1%. As SQ’s primary target market
is SMBs or mid-sized businesses, the TAM seems exaggerated. While SQ made quite a
noticeable progress in shifting from micro and SMB segment to larger businesses, the vast
majority of the enterprise segment may remain out of reach for SQ (Adyen, for example,
dominates the enterprise segment). Nonetheless, this exaggeration of TAM does not necessarily
mean their growth runway is bounded by the size of its “real” TAM. For context, SQ’s transaction
gross profit from sellers in 2020 was estimated to be $1.2 Bn. Even if we assume SQ won’t be
able to gain any traction in enterprise segment (>$100 mn sales) and hence cut the TAM by
~50%, we are still looking at penetration of mid to high single digit. One of the recurring themes
in this deep dive is that payments markets are just so large that size of the market is usually the
least of our concerns.
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SQ estimated its Software opportunity in the seller ecosystem to be $30 Bn. They took the number
of firms making <$100 mn sales in relevant industries such as retail, restaurant etc. and multiplied
that by ARR per existing seller on SQ. I estimate SQ’s software revenue in the seller ecosystem
to be ~$285 mn in 2020.
Opportunities in Square Capital, and financial services were estimated to be $12 Bn and $5 Bn
respectively. Square Capital’s loans range from $300-$250k, so they took the aggregate small
business loans under $250k in the US and multiplied the number by ~5% spread to estimate the
TAM for Square Capital. In 2020, SQ distributed $1.83 Bn loan to the sellers. In its 10-k, SQ
mentioned from SQ Capital’s initial launch in 2014, they facilitated 1.2 mn number of loans which
aggregated to be $8.1 Bn cumulatively. This implies an average loan size of $6,750. SQ Capital’s
loans operate very differently compared to traditional banks’ loans.
Sellers who are eligible for loans typically see the message/option on their platform and ~90% of
the sellers who were offered the loans accepted it, implying the nature of latent demand there.
SQ typically caps the loan size at ~20% of annual gross sales. Since SQ already has all the data,
the process is automated and does not require any lengthy application/process. SQ preemptively
chooses the borrower and they just either accept/reject the offer. Traditional players in lending
will have a very difficult time in competing against SQ in this segment. Moreover, the way these
loans get repaid is also fundamentally different compared to traditional lenders’. SQ does not
mention interest rate on the loan, rather they price these loans as a fixed fee as % of sales that
will be deducted directly every time a sale occurs.
For example, if you take 18-month loan of $10k from Square Capital, SQ may let you know that
you will pay a fixed total fee of $1k (illustrative example; it may vary) over the course of the next
18 months, in addition to the principal. SQ will then take a fixed percentage (say 8%) from every
sale until the cumulative repayment reaches $11k. The borrower has the option to repay faster
without any penalty. Interestingly, because of the fixed fee nature of the “interest rate”, if a seller
repays faster, he/she is effectively paying a higher interest rate and it is probably in his/her best
interest to just go with SQ’s plan. SQ mentioned sellers typically repay loans in less than 9 months.
Please note Stripe Capital, Shopify Capital, or Toast Capital all offer the same type of loans. John
Collison, Stripe’s co-founder, once responded to a thread on Hacker News about this perverse
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incentive since borrower effectively pays higher interest rate by repaying faster. Collison
responded: “What we heard overwhelmingly from customers, though, is that the downside risk of
credit obligations they can't meet (liquidity problems are asymmetrically damaging!) substantially
outweighs the theoretical "risk" of a higher effective APR caused by significant outperformance in
the business. (Stated differently, we're taking the risk of your business underperforming, in return
for you paying us back somewhat faster -- but still at a capped rate -- if things go better than you
expect.)”
With its recent launch of “Square Financial Services” and “Industrial Loan Corporation” in 2021,
SQ can provide even a wider range of financial services to its sellers. As SQ continue to gather
more data from its sellers’ history to gain a better understanding of the risk profile to price loans
appropriately and penetrate further in multiple industries, SQ loans can be a sizable business.
This repayment process reminded me of the famous quote by Robert Smith from Vista Equity
Partners: “Software contracts are better than first-lien debt. You realize a company will not pay
the interest payment on their first lien until after they pay their software maintenance or
subscription fee. We get paid our money first. Who has the better credit? He can’t run his business
without our software.”
Given the repayment process, SQ effectively has the first claim on the *sales* of the business
before the seller can spend on any other operating expense (salaries, rent etc.). Therefore, unless
the seller is literally out of business, SQ will get its money back. Of course, SMBs have high failure
rate, so this still does not save SQ from incurring some losses. Loan losses typically hovered
between 3-4% of loans.
Given that SQ distributed $1.8 Bn loan in 2020 and assuming ~5% spread, SQ loans generated
<$100 mn revenue in 2020. Given the potential size of the demand for loans in this segment, it is
very much conceivable that this business can grow for years without regressing to mean anytime
soon.
When you add high margin ancillary fees business on top of SQ loans, I think SQ Capital/Financial
Services has a compelling potential. SQ mentioned while the active sellers grew 1.7x in 2015-
2019, gross profit per seller increased 2.3x during the same time. Unit economics seems to be
quite lucrative as well. Payback period was consistently below four quarters and yielded >5x ROI
on SQ’s go-to-market spend. While SQ showed these charts/graphs on its Investor Day last year,
they do not disclose enough data to let analysts run the numbers.
It is important to note that almost all the products/services that I have mentioned so far has plenty
of competition in the market and in many cases, the products are remarkably similar in terms of
utilities and pricing. Ultimately, what can differentiate SQ from the rest is the same thing that
differentiated it from AMZN when it tried to enter the market. SQ’s integrated ecosystem for sellers
appears to be more convenient for sellers to manage compared to many other alternatives out
there. If you pick just one particular product, you will find at least half a dozen alternatives, but SQ
still seems a bit ahead in terms of building the whole integrated ecosystem which will only be
strengthened further with its recent banking services. When you add Cash App and After Pay
acquisitions (discussed in section 2, and 3 later), I would rather be in SQ’s position today.
Moreover, one perhaps underappreciated aspect of SQ’s advantage is how intuitive its products
are and the elegant design of the products.
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Nonetheless, SQ is likely to face very tough competition in niche segments. For example, Toast,
a competition for “Square for Restaurant”, recently filed for IPO at ~$20 Bn valuation and can
prove to be very competent and perhaps a better alternative given their focus. Overall, SQ’s
ultimate strength is likely to be the integrated ecosystem which includes sellers AND customers
whereas its vertical specific competitors are likely to be more focused on just one side of the
equation.
Beyond the US, SQ sized its international market (Canada, Australia, UK, Japan) opportunity to
be $16B+. Given the size of the opportunity in the US market itself, I do not think the international
story still has significant importance and while acquisitions such as APT does give them an entry
point in some international markets, the overall path to success in international markets is not
clear.
Section 2: The Cash App
While SQ was founded to serve sellers and help them accept card payments, over time SQ not
only kept adding new use cases and services for its sellers but also went well beyond the sellers.
SQ launched Square Cash (now known as Cash App) in 2013 following a hackathon event to
introduce peer-to-peer payments.
Dorsey asked Robert Anderson, then product design lead at Square, to design a product so
simple that it wouldn’t even have an interface. After looking at Anderson’s initial designs, Dorsey
suggested him to visit MoMA. Dorsey repeatedly mentions influence of art in his ideas and
approach to building. Every SQ products I have looked into the past month, all of them are very
simple, intuitive, elegant, and beautiful in design. Considering a consumer wallet or any financial
app inherently consists of utilities or commoditized services, it is easy to underappreciate how an
app with simple, intuitive, and aesthetic features can enjoy a significant leg up over its competitors.
I encourage subscribers to read how Square Cash was developed as I believe this not only
provides a peek at how Dorsey operates and leads SQ but also how all of their products have a
sense and appreciation of art.
At first glance, there is hardly any “synergy” between the sellers ecosystem and the Cash App as
they both appear to be run separately as independent segments. While seller segment does not
enjoy any network effects, Cash App certainly does. As you pay or request money to/from your
friends, you keep adding people to the Cash App network. As more people joined the network,
SQ kept adding new products and use cases within the app.
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Today, Cash App, as shown below, has three main features: sending money, spending money,
and investing money. Again, for the sake of brevity, I have hyperlinked the products/revenue
stream for interested readers to explore. While instant deposit (1.5% charges to transfer money
instantly from Cash App to your bank account) is likely to be the largest gross profit revenue
stream today for Cash App, one counterintuitive aspect of building a successful closed loop
payment system is this revenue stream will fall or completely evaporate (in the extreme case of
100% closed loop payment system) if people just use Cash App to pay for products/services. But
such concerns miss two key aspects: a) if more and more Cash App users use the app as “bank”
account, the stored balance will increase materially some of which SQ can utilize to fund loans to
sellers, and b) the benefit of building closed loop in aggregate (sellers+ Cash App) is likely to far
outweigh the loss of revenue from instant deposits and interchange fees.
Activity Engagement Revenue stream Transaction- Subscription Bitcoin
drivers based and services
Sending Peer-to-Peer • Instant ✓ ✓
money Deposit
• Cash for
Business
• Credit Card
funding
Spending • Boost • Cash card ✓
money (rewards) interchange
• Stored • ATM
balance withdrawals
• Direct • Interest
deposit income
Investing • Bitcoin Bitcoin trading ✓
money • Equity
Investing
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The ultimate dream for a fintech or payment company is to build a closed network payment loop
instead of the open network system that requires you to leverage the network of Visa/Mastercard.
As mentioned in Section 1, when a consumer is using the payment rails of the V/MA on SQ card
readers, the merchants pay ~3% to allow you the privilege and ~2% of the Gross Payment Volume
(GPV) is distributed to the participants in the system which leaves the rest ~1% for SQ. But
imagine a situation when Cash App user goes to a restaurant and transfers money from his/her
Cash App to the seller Cash App business account to pay for the food. Merchants would probably
still pay ~3% to accept payment (but SQ could potentially make it lower to incentivize sellers), and
SQ can keep all of it, instead of ~1%, to itself. Well, you don’t have to imagine, just see yesterday’s
press release by SQ.
Dorsey had this ambition as early as 2013; in his speech at Stanford, he alluded to his ultimate
dream that customers would go to store and pay for the product/service through Square’s
ecosystem without even realizing they are using its products. Of course, it requires a lot of
investment and a sense of ubiquity which is excruciatingly difficult to create. SQ itself understood
the extent of difficulty as its deal with Starbucks, which it hoped would help them realize this
potential closed network loop, did not pan out at all. Even though it did not work then, the dream
is still there and if Cash App’s Monthly Active Users (MAU), currently more than 40 mn, crosses
some critical threshold with expanded use cases such as basic financial services, SQ is likely to
try to integrate its two independent networks (sellers and Cash App) again. Today, sitting in the
US, you can send money to someone in the UK via Cash App. Or to put it differently, if you are a
New Yorker, you can travel to London or Texas and pay via Cash App without using V/MA rails if
the restaurant you are visiting has “Cash App” for business.
Because of the juicy economics and potential size of the reward I expect SQ to always keep this
end-state in mind as they keep building their ecosystem. How likely is it that SQ will be successful
in building the closed payment loop? Two things I would like to highlight here:
a) V/MA’s open payment rail is perhaps the widest moat available in capitalism given network
effects among three-sided networks: consumers, merchants, and their banks. It still seems a
herculean task (but perhaps not impossible) to me for anyone to meaningfully disrupt this moat.
b) A lot depends on the extent to which Cash App is used as the de facto bank account by the
users. Will Cash App users keep extra funds on the app and use their wallets to directly pay for
stuff or are they going to remain pretty satisfied with their debit or credit cards? As a consumer,
whenever I receive cash in my Venmo or Cash App, I just transfer it to my bank account, and I
am happy to use my cards today for daily transactions. Since I hardly ever need the money
instantly, I don’t pay instant fee as well. It is, however, important to remember that I am probably
not the target customer for Cash App. But SQ mentions many of the Cash App users use their
wallet as their “bank account”. This is particularly relevant for low-income people who may not
have much connection with traditional financial institutions and SQ’s Cash App may be their first
point of interaction with financial services. While V/MA deals with trillions of dollar of payment
volume, even if SQ can keep couple hundred billion dollar (i.e. ~20% of GPV) in the closed
payment loops in the next 10 years, it can be a sizable opportunity for SQ which I will explain in
Section 5.
Venmo (acquired by PayPal in 2014), the largest peer-to-peer payment app in the US and Cash
App’s biggest competitor, was launched four years before Square Cash/Cash App. While both
apps enjoy network effects as one needs to join the network to accept payments from their friends,
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they have different approaches. Venmo has a public social feed through which you can see
payment activities of your friends in the network (but can be manually changed to private while
sending money to someone). Cash App is private by default. When you open Cash App, the app
prompts you to type the amount you want to pay/request someone, and you can send them the
amount via email/text message, or $Cashtag (unique username followed by $).
It is my opinion that Cash App’s approach to peer-to-peer payment is likely to prove superior to
Venmo’s. When I open my Venmo app, I hardly see any interaction at all among the users except
for the people involved in the transaction (typically just a lazy <3 react in the post). In fact, I could
easily imagine multiple scenarios in which sharing your payments publicly can lead to whole host
of socially awkward situations for the users. If you forget to invite a friend to your party, your
uninvited friend later can see everyone in the group paying you over Venmo for the party. Or if
you ever added your parents/relatives to your network, they could see how many days a week
you are going out for drinking. These scenarios are relevant since Venmo became popular via
students in college campuses who needed to split the bill for different activities with their friends.
Even beyond these basic socially awkward situations, there is a question of breach of privacy
because of Venmo’s default public setting for payments which did get some attention in the press.
Recently, Venmo removed its global, public feed to “friends only” feed; it still does not quite solve
the issues I mentioned earlier.
Cash App doesn’t have any of these issues because of its private by default setting which I believe
will let it continue to build a more robust and inclusive network than Venmo over time. You can
invite your friends, colleagues, or even grandparents to Cash App without any of the concerns
laid above, and the network effects of Cash App can sustain without reaching the invisible
asymptote probably for quite some time. If you see the google trends in the last 5 years, Cash
App clearly broke through last year. While this primarily happened since many users were using
the Cash App for receiving stimulus payment/tax refunds, I think Cash App is likely to supersede
Venmo over time because of its more convenient and user-friendly approach to peer-to-peer
payment.
SQ mentioned Cash App had more than 40 mn Monthly Active Users (MAU) in 2Q’21, 2/3 rd of
which are also weekly users. SQ does not report annual active accounts at regular intervals, but
it did mention Cash App annual user base of 70 mn vs Venmo’s reported annual user base of 76
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mn. Despite the late start, Cash App is clearly catching up soon and may be set to eventually
eclipse Venmo.
It’s not just stimulus payments and tax refunds that let Cash App gain momentum. Cash App
capitalized on social media engagement to popularize the app and catch up with Venmo. As you
can see below, Cash App is ahead of Venmo in every major social media in terms of number of
followers. Cash App generally gives out money randomly to users who comment/reply with their
Cash App user name every Friday under the campaign #CashAppFriday. On
“#SuperCashAppFriday”, Cash App random gives away $10k. To be eligible, you just need to
retweet with your $Cashtag. They also partnered with celebrities such as Miley Cyrus and Megan
Thee Stallion for $1 Mn giveaway to Cash App users randomly. Such viral marketing strategy led
Cash App’s Customer Acquisition Cost (CAC), as per 4Q’20 earnings call, to be less than $5 per
customer. I should note that how companies define CAC varies considerably and it appears SQ
defined CAC here as just referral fees/performance marketing/brand spend costs and does not
include full range of costs. On its last investor day, SQ showed for 2017 June cohort of Cash App
customers, payback was less than 12 months and cumulative cohort variable profit or ROI
increased >5x in 2.5 years. Again, SQ does not periodically disclose enough data for us to
independently track these numbers. In any case, it is clear that leveraging social media and the
network effects, Cash App was able to grow from just 7 mn MAU in 2017 to 24 mn in 2019 and
36 mn in 2020.
Social Media Cash Venmo
App
Twitter 1.2 M 334.5K
Instagram 1.7 M 1.3 M
Facebook 139K 84K
Data collected on September 04, 2021
While Cash App users start through paying/receiving money from someone, SQ monetizes these
users via seven different revenue streams (4Q’19 earnings call). A gamechanger from the
perspective of SQ is when a user adopts Cash Card. Before adopting Cash Card, almost all of
the revenue generated from a user comes from instant deposit. But after receiving Cash Card,
users graduate from “sending money” to “spending money” which leads to revenue uplift from
interchange fees, ATM withdrawal fees etc. Although SQ reported 40 mn Cash App MAU in 2Q’21,
Cash Card had ~10 mn MAU (7 mn weekly actives). One of the incentives for users to try Cash
Card is the “Boost” feature which allows users to save money and enjoy various discounts/offers
such as $1 off at coffee shops, 10% cash back at Trader Joe’s and Whole Foods, and 15% off at
Chipotle and Shake Shack etc.
Finally, users graduate from “spending money” to “saving money” as they invest in stocks or
bitcoin. In 4Q’20 earnings call, Dorsey mentioned, “In 2020, more than 3 million customers bought
or sold Bitcoin in Cash App. And in January 2021 alone, more than 1 million customers bought
Bitcoin for the first time.”
While SQ clearly wants to build a financial super app, there are some blind spots. If you are
building a super app, you need to have all the utilities/financial services customer want. So what
are some obvious services that are missing today? Or to put it differently, what other apps do you
need today on your phone apart from Cash App to receive the financial services you want/need?
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While you can invest in stocks via Cash App, you cannot do options trading. If Robinhood’s
success is any indication, that is clearly a blind spot and customers probably need to have another
brokerage app that allows options trading. Interestingly, SQ seems to have taken an ideological
position on bitcoin and hence Cash App does not allow trading in any other crypto. This is
particularly concerning since Venmo just joined the crypto bandwagon in April 2021 by letting its
users trade in four crypto coins: Bitcoin, Ethereum, Bitcoin Cash, and Litecoin. I have no particular
opinion on any of these coins, but I think it is fair to say these coins are considered “legitimate”
by the vast majority interested in crypto. By not allowing trading these coins, Cash App is
essentially forcing its users to install another app (Coinbase, Venmo, Robinhood etc.) on their
phones.
An interaction between Dorsey and a twitter user couple of years ago can be revealing as to why
Cash App does not allow trading other coins:
Dorsey’s twitter bio is “#bitcoin” (yes, that’s it) and he appears to be “bitcoin maximalist”. While I
could possibly ignore his personal opinion on some currencies, it can potentially limit Cash App’s
ambition to be the super app. Ethereum’s market cap (~$450 Bn) is half of bitcoin’s market cap,
so clearly there is a potential demand for Ethereum trading from Cash App users. As I was
watching Dorsey’s interview with Lex Fridman, it was clear he deeply wants bitcoin to be the
native currency of the internet and the world. Dorsey explained as much as he wants SQ to be a
tech company, it is hard to be one with all these different regulations and currencies in place in
every country out there. While I am happy to respect his opinions or wishes, I believe Cash App
and SQ would be more benefitted if they do not oblige to Dorsey’s personal predilection to bitcoin.
Despite these potential blind spots, Cash App is in an enviable position in the broader fintech app
space because of its broader range of utilities/services. While there are many other (Venmo,
Robinhood, Coinbase, Zelle, Revolut and who knows what else) are trying to be the super app,
Cash App and Venmo are probably ahead of others at the moment. Given the size of the broader
opportunity, it may not have to be one single winner and could potentially settle to two-three super
apps over the long term.
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Section 3 APT: Quasi-marketplace masquerading as BNPL
Buy-Now-Pay-Later (BNPL) has been a really hot topic in the fintech world. With SQ’s acquisition
of Afterpay (APT) for ~$30 Bn (since SQ will pay in stock, it depends on SQ’s stock price),
everyone in the ecosystem is taking a closer look. Given the size of the deal, you can probably
understand that it is very much possible to write 20–30-page deep dive just on APT. While I will
leave plenty of reading materials for curious readers at the end of this month’s deep dive, I will
condense my understanding on BNPL and primarily focus on the three following questions:
I. How does BNPL/APT work?
II. What is the competitive environment in BNPL?
III. How does APT acquisition make sense in SQ’s long-term ambition?
I. How does BNPL/Afterpay work?
As the name suggests, BNPL allows consumers to buy a product today and pay for the product
later. While companies within BNPL space can each have slightly different approach, I am just
going to focus on APT here while discussing about the business but will engage in the competition
related discussion later.
There are three participants in a transaction: consumer, merchant, and Afterpay (APT). Let me
discuss each of them separately.
Consumer
APT consumers pay 25% of the initial price of the product, and then pay three equal installments
every two weeks from the initial purchase date. The three installments are essentially 0% interest
loan. Whether you pay each installment in time or not, the consumer does not pay any interest to
APT. If you miss a payment, you will be charged a $10 late fee+ additional $7 if you are a week
late (total late fees is capped at 25% of the purchase value). Once you miss any payment, you
won’t be able to do any other transaction via APT before you start repaying.
The three key differentiators between APT (NOT necessarily applies to all BNPLs) vs credit cards
are:
a) While consumers need to apply for credit card and wait for approval after credit score checks,
APT users have instant access to credit.
b) Instead of the maximum four-week payment cycle for credit cards, APT consumers get six-
week cycle. It’s not quite apple-to-apple since APT consumers will have to pay in two-week
intervals vs credit card holders can wait for maximum (depending on your purchase date in your
payment cycle) four whole weeks before paying it off to not get charged interest.
c) Unlike credit cardholders, APT consumers do not face the wrath of escalating interest if they
miss payments. Instead of compounding interest, they just pay flat late fees.
Beyond these factual differentiators, I do not think it is good business practice that credit card
companies still show “minimum payment amount” in monthly billings which research shows to be
misleading for low numeracy consumers. One disadvantage of using APT instead of credit cards
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is it does not build your credit history. It is also difficult to provide consumers large balance of
credit because of the credit risk. As a result, available credit is kept at less than $2,000 today for
APT users, average order value is $153 and average outstanding balance is just $190. Therefore,
for high-income (or spending) consumers, APT isn’t necessarily a replacement of credit cards
today.
So who exactly uses APT’s product? The typical consumer is 33-year-old woman.
Investors typically focus on BNPLs such as APT as payment company and most discussion
seems to revolve around whether BNPL can disrupt credit card. While credit card usage can
potentially come under some pressure because of BNPL, it appears to me that credit card and
BNPL are more of complements than substitutes today. As per Cardify: “Over 62% of BNPL users
were carrying 75%+ of their card balance unpaid when they first engaged with instalment
payments.” Interestingly, it does not necessarily mean that these users ran out of money and
hence resorted to BNPL. The same report indicated ~80% of users can cover the entire payment
but still chooses to use BNPL, presumably for better financial management, and convenience of
the BNPL/APT app. Therefore, BNPL users are not necessarily leaving credit cards in drove to
use BNPL, rather supplementing credit cards with BNPL.
Source: Cardify
Merchants
As per APT, when partnering with APT, merchants on average see >25% lift in Average Order
Value (AOV), >20% lift in conversion, and >20% lift in frequency. APT also supposedly has lower
return rates. Much more importantly, APT generates demand for its merchants/brands as it drives
~1 mn lead referrals per day for merchants, 55% of which come from the APT app itself. Moreover,
brands/merchants and APT can run shared marketing campaign to drive sales. I have received
quite a few Labor Day sales promotion notifications from the app as I recently installed the app.
While APT primarily focuses on beauty/fashion category today in the US, its Australian website
may give us a peek to the future in which beauty/fashion contributes just ~35% of GMV. While I
will discuss the numbers in a later section, please note APAC, primarily Australia (~45%) and
North America, primarily the US (~47%) contributed ~90% of the overall GMV of AUD $21 Bn in
FY’21.
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US website:
Australia website:
APT has a very engaged userbase and sometimes they ask users, “I wish _____ offered
Afterpay.” Once they get the result, they can go to the brand, and show them the average data
points I shared earlier about uplift in AOV, conversion rates, frequency etc. and how APT users
are specifically asking for their brand to be listed on APT.
That’s exactly how they landed Lululemon. As per Hayden Capital, “When Afterpay first did a
similar tactic with Lululemon, Afterpay’s fans bombarded Lululemon’s customer service lines.
Lululemon actually had to ask Afterpay to tell its fans to stop bombarding the phone lines, as there
were so many calls Lululemon couldn’t serve their regular customer calls. Of course, Lululemon
now offers Afterpay as a payment option.”
Klarna, which is the market leader in Europe while APT leads APAC and the US, has
brands/marketplace such as Etsy, Nike, Farfetch listed on the app although I did not find any of
them on APT’s app. I don’t know why that is the case, but it is possible with time APT will be able
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to land all of these brands. Let’s imagine over time they all list on APT app and consider the
following.
If a customer is willing to pay via BNPL and start their shopping journey from APT app which
majority of them currently do, customers don’t need to install or download
LULU/ETSY/NKE/FTCH app on their phones. Instead of downloading tens of different apps,
customers can just install APT and search for the brands/products within APT app. This
essentially implies APT will be aggregating demand and I am of the opinion that in a world of
abundant supplies, aggregating demand will be more and more valuable. What I find somewhat
strange is APT (or any BNPL) is treated as commodities by these brands today. Even if you start
your buying journey from APT app today and click Lululemon to buy a t-shirt, LULU still shows
you other payment options in the checkout (Paypal and credit card in addition to APT).
Today, brands are the clear winner in this value chain. They get to enjoy higher sales (higher
AOV, traffic, frequency) without taking any credit risk. Once more brands join APT, I think it is
possible that the leverage in this relationship can flip on its head and APT may demand exclusive
payment option in the checkout when a customer starts their buying journey from the APT app, a
very reasonable ask in my opinion. Even if such exclusivity remains unpalatable to brands, it is
highly likely APT will monetize its ability to send traffic to these brands one way or the other once
it reaches a decent scale.
Afterpay
Now that I explained the consumer and merchant perspectives, let me elaborate how APT makes
money.
APT charges 3-6% of the purchase price which is paid by the merchants. For example, for a $100
item, consumers pay $100 and merchants receive $94-97 upfront from APT. If consumer pays
back in time, APT keeps 3-6% of GMV. If consumer does not pay back in time, a late fee is
charged. Late fees accrue for only ~10% of total APT revenue. Interestingly, APT mentions on its
website, “at Afterpay, we never do credit checks or report late payments. We don’t believe in
preventing people from accessing Afterpay because they may have had an old debt from a long
time ago.”
~90% of the loans are paid back via debit cards and the average duration of the loan is just three
weeks as many choose to repay the loan sooner. Given the duration of the loans, APT can utilize
its capital ~17x per year. Based on these estimates, we can calculate ROIC for APT. Assuming
~4% take rate, 20% pre-tax margin, and 17x utilization of capital can lead to 13.6% return
($100*4%*20%*17). Since APT does not fund its loans entirely through equity, return on equity is
much higher.
How does APT fund its loans/receivables? APT has secured warehousing facilities, as shown
below, from National Australia Bank (NAB), Citi, Goldman Sachs, and Bank of New Zealand.
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Even though APT does not pressure consumers to pay back the loans (you just lose access to
any more credit after missing a payment), loan loss was just 0.92% of GMV in FY’21. While at
first glance it seems like a pretty low number, please note that it is ~20% of APT’s revenue
because of the overall take-rate of ~4% for APT.
APT’s take rate of 3.9% makes sense if you consider it to be a payment company and compare
it against credit cards which also lead to 3-4% fees for merchants. But I think payment is a feature
and the real product here is the aggregation of brands in one single app which happens to allow
you to pay via BNPL (and you can also change the payment method if you want).
There is no fixed take rate applicable for every merchant out there. A brand such as LULU
presumably pays a low take rate such as ~3% and my guess is APT probably pitches LULU “hey,
you pay the same rate as you would for credit cards and we will provide you more traffic, higher
AOV etc.”. Of course, the value of APT’s app increases significantly when a brand such as LULU
is in it. But when APT pitches to lesser-known brands, their pitch is probably different. Then the
pitch becomes “hey, we have an app with 16.2 mn users who are actively using and searching
for products your company sells. Why don’t you list your brand in our app? By the way, since we
are going to increase your sales and traffic, we will keep 6% of the sales.”
The important thing to note is APT has specific data in terms of how much traffic, AOV, and
conversion rate it has provided to each brand. When they have a large enough user base, the
conversation they are having today with smaller brands/merchants will probably also happen with
some of the bigger brands out there in the long run. If you can generate demand and if customers
start their buying journey from your app, frankly speaking 6% take rate is simply too low. V/MA
does not generate demand for LULU/ETSY, but if APT does, it is very conceivable to me that
LULU/ETSY will have to pay for that traffic eventually. In addition, every (quasi)marketplace
inevitably will sell ads which is also very high margin revenue. Overall, the more I thought about
it, the more I realized APT is a demand aggregator and BNPL is a sideshow. My confidence on
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this conclusion grew even further when I read Mac Ruby’s piece on “After Afterpay” in which he
mentioned the following:
“Afterpay argues that its model is increasingly analogous to an internet referral platform like
Google rather than to a payments processor like Visa. Indeed, in the year to June 2021, Afterpay
drove ~1 million lead referrals per day to its merchant partners, with 55% coming from consumers
browsing the home page on the Afterpay mobile app. Since its early days, the company has
shifted its focus from merchant-as-customer to consumer-as-customer. The merchant partner
finances Afterpay’s customer acquisition, but then gets value back through referrals and repeat
business. One analysis shows that leads from Afterpay convert 8x more than leads from Google;
lead referral is a growing part of the proposition for merchants.
The Governor of the Reserve Bank of Australia plainly agreed and in December 2020, indicated
that he would not remove the no-surcharge rules that would have put Buy Now Pay Later on equal
footing with card processors.”
Today, APT’s business is a bit fragile since if loan loss rate increases by just 100-200 bps in an
economic recession, that implies >40-60% of revenue. But if the take rate is ~5-6% or even higher
(generating demand for brands is likely to be very valuable in the long run), the business will
become much more robust.
II. What is the competitive dynamic in BNPL?
While working on SQ deep dive, I decided to install Afterpay app on my phone. When I opened
the app, it reminded me of Shopify’s “Shop” app. Like Shop app, it has categories such as “Shop
local”, “Shop women owned Businesses” etc. Unlike Shopify, APT is not too shy to build a
marketplace aggregating all the brands which is easily searchable by users. I wonder whether
Shopify’s narrative of “arming the rebels” and sole focus on merchants could become a bit limiting
for them to realize the full potential of the Shop app.
Klarna is usually labeled as the direct competitor of APT. As per the latest private round, Klarna
is valued at $45.6 Bn. In 1H’21, Klarna reported $39 Bn GMV whereas APT’s full FY’21 (July-Jun)
reported GMV was AUD $21.1 Bn. However, these broad GMV numbers mask a lot of nuances.
Klarna has three products: a) BNPL (similar to APT), b) financing products (consumer loan for 3-
36 months at ~20% APR), and c) Pay in 30 (customers order multiple items and pay within 30
days for items they decide to keep and return the rest). While APT just provides the BNPL product,
Klarna’s GMV consists of all three products, making the apple-to-apple comparison difficult.
Moreover, as you can gauge, Klarna’s business model inherently takes much more credit risk
than APT’s.
Similarly, Affirm which also provides BNPL services seems to have a much broader ambition than
APT. Max Levchin, co-founder and CEO of Affirm, said the following in 2015: "We are building a
new bank, hopefully the largest bank in the world, by using technology from the ground up. Today,
we help them buy mattresses and sets of dishes; tomorrow, a used car, maybe a new car, then a
house." You really cannot accuse the “PayPal Mafia” that any of them lacks ambition. Affirm, with
their deal with Shopify, Amazon, and Walmart, seems to be aspiring for ubiquity and
commoditization of the BNPL services. As mentioned earlier, while all these companies on the
surface seem to provide the same BNPL services, each company is approaching it differently.
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Of all the BNPL companies I studied, APT appears to have the least risky business model from
credit risk perspective. APT and Klarna seem much more interested in building their brand and
create a sense of affinity/relationship with the end customers. Klarna is a clear market leader in
Europe while APT is the clear leader in the US and Australia. As you can see below, monthly
traffic to APT, AFRM, Klarna website/app clearly indicates the distance between APT and the
other two BNPL service companies. As a testament to different approaches, APT emphasized on
customer starting their journey from their website/app whereas AFRM seems to be more
interested in being just a payment/financing utility attached on major e-commerce
websites/marketplaces. While Klarna has similar approach to APT, they are more focused in
Europe. The global, ex US traffic data primarily indicates traffic to APAC sites, especially Australia
for APT while almost all of Klarna’s global traffic, ex-US comes from Europe. APT operates in the
UK under ClearPay brand and recently acquired Pagantis (Spanish fintech company), Empatkali
(Indonesian BNPL company), and Postpay (12.5% equity stake at Dubai-based BNPL company).
Although they are clearly trying to grow their footprint beyond Australia and the US, APT may
remain a distant second in Europe.
Monthly Web/mobile traffic in the US

(Mn)
20.0
15.9
15.0
10.0 6.7
5.0 2.4
0.0
Jan-19
Jan-20
Jan-21
Mar-19
Mar-20
Mar-21
Sep-18
Nov-18
Sep-19
Nov-19
Sep-20
Nov-20
May-19
May-20
May-21
Jul-18
Jul-19
Jul-20
Jul-21
Afterpay Klarna Affirm
Monthly Global web/mobile traffic, ex-US

(Mn)
25.0
19.4
20.0
15.0 10.8
9.9
10.0
4.7
5.0
0.0
Jan-19
Jan-20
Jan-21
Sep-18
Nov-18
Mar-19
Sep-19
Nov-19
Mar-20
Sep-20
Nov-20
Mar-21
May-19
May-20
May-21
Jul-18
Jul-19
Jul-20
Jul-21
Afterpay Klarna
Source: Similarweb
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III. How does the acquisition of APT may make sense for SQ’s long-term ambition?
On August 1st, Square announced that they would acquire Afterpay (transaction is likely to close
in Q1’22). The following day, SQ was nearly +10%. After studying both SQ and APT, I think Mr.
Market was directionally right.
Given APT’s ambition of being a demand aggregator, the sooner it gets bigger, the better shot it
has to reach the scale required to enjoy any leverage in their take rate negotiation with
brands/merchants. With SQ’s acquisition, it is likely that APT will be integrated within Cash App.
Both Cash App and APT provide commoditized services, and yet both these apps were able to
create authentic, direct, and sticky relationship with the end customers. At one hand, SQ is likely
to extend its footprint in Australia on the back of APT and APT is likely to be able to accelerate its
customer base in the US on the back of SQ. Following the acquisition, the distance between
Klarna and APT is likely to widen even further than it already is today in the US.
While every SQ’s product has bit of an elegance attached to it, APT’s UX, in my opinion, doesn’t
quite have that aura. If SQ can bring their design elegance, integrate APT to Cash App, and
turbocharge “spend money” function via Cash App, it can be mutually beneficial for accelerating
the S-curve for both Cash App and APT. SQ’s recent POS focus on beauty/wellness also
complements really well with APT’s stronghold on beauty/wellness. Instead of paying the
installments via a bank debit card, customers can utilize the Cash App to repay their loan.
I have heard the skeptics’ concerns about the acquisition. Many questioned whether SQ should
have tried to build BNPL itself instead of paying such a hefty price for it, and some mentioned
how PYPL’s pioneering acquisition of “Bill Me Later” 13 years ago for <$1 Bn appears quite
prophetic now. However, I think this skepticism misses a core point. SQ is not buying APT
because of the BNPL feature; they can probably build it in a week. They are buying APT because
APT has done an excellent job of building an accelerating network effect among consumers and
merchants/brands in addition to creating habit formation for its users. It would be very, very difficult
and time consuming to recreate that magic via an organic approach.
PYMNTS.com had a good piece on the SQ-APT acquisition deal and the impact of the deal on
everyone in the payment ecosystem:
“The acquisition is an opportunity for both Square and Afterpay to scale a two-sided, multichannel
payments, commerce and financial services ecosystem that also leverages Square’s integrated
POS platform and merchant services capabilities to keep and grow an expanded merchant base.
In theory, the acquisition provides both Afterpay and Square’s Cash App users with an incentive
to do more business within their newly formed ecosystem, given the added credit/debit/shopping
capabilities each provides to the other. With Square’s industrial bank charter, more banking and
financial services capabilities will likely extend the functionality of this network over time for
consumers and merchants — and grow quickly as network effects kick in. That will attract even
more merchants to the platform, which will attract even more consumers, and so on as the virtuous
circle spins…
…In light of the Square/Afterpay news, success in the BNPL space comes down to platform
ignition fundamentals: what’s needed to create critical mass and network effects for whom — at
scale — in a timeframe that’s relevant, and with enough cash to outbid the competition.”
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Ben Thompson also made similar arguments and explained how this deal is likely to unlock value
for both SQ and APT:
“What is so intriguing about the Afterpay acquisition by Square specifically is the potential for
1+1+1 to equal far more than 3. Start with the obvious synergies: Square’s merchant base will
automatically have access to Afterpay, and and Afterpay’s merchant base will have access to
Square (helping Square expand in Australia in particular). What is even more compelling, though,
are the transformative effect this acquisition could have on Square’s network effects.
First, recall that Afterpay has created a network effect between consumers and merchants;
Square is going to insert the Cash App directly into this relationship.
This will not only drive adoption of the Cash App by consumers who wish to BNPL, it also
increases the frequency with which consumers might use the Cash App for purchases in general.
This deepens the moat for both Afterpay and the Cash App and improves Square’s margins.
Second, the most obvious way to make your Afterpay payments will be with the Cash App, not
your debit or credit card. Payments made from your Cash App balance will be very high margin
for Square (which it can potentially pass on to merchants), and the obvious fallback will be the
bank account already linked to the Cash App account, which should further reduce Afterpay’s
credit card fee exposure. The end result is a multi-part network that is not quite as impenetrable
as Visa’s, but it’s much more compelling than what Square had previously:
Square had a consumer business and a merchant business and it bought a network effect
between them.”
Section 4: Regulatory arbitrage and potential headwind
Jamie Dimon in his most recent shareholder letter shared the following interesting comparison
between banks and fintech/nonbanks to make his point that regulatory environment is vastly
different for big banks and fintech companies such as Square/PayPal. At one point in his letter,
he specifically highlighted Durbin Amendment for the divergence between big banks and fintech:
“And because of the Durbin Amendment, if a bank has a customer with a small checking account
who spends $20,000 a year on a debit card, the bank will only receive $120 in debit revenue –
while a small bank or nonbank would receive $240. This difference may determine whether you
can even compete in certain customer segments. It’s important to note that while some of the
fintechs have done an excellent job, they may actually be more expensive to the customer”
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So what is this “Durbin Amendment”? It’s an extension within the Dodd-Frank Act which capped
the interchange fees that banks could charge merchants on debit card transactions. Before the
law, banks made ~44 cents per debit card transactions in interchange fees. Since this was
deemed too high, following the amendment the interchange fees were capped at 21 cents+0.05%
of transaction value+ 1 cent for fraud protection cost. Of course, post-GFC these regulations were
primarily directed at Bulge Bracket or SIFI banks, so banks under $10 Bn in assets were exempted
from this regulation which allowed smaller/regional banks, as shown below, to charge much
higher than big banks.
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Fintech/Neo banks took full advantage of this regulatory loophole. They partnered with regional
banks under $10 Bn assets to offer debit cards to their customers. The cut for the bank is fairly
minimal (~3 bps) whereas the fintech/Neo banks could keep ~80-100 bps per transaction. As
Dimon indicated in his letter, the unintended consequence of Durbin Amendment turned out to be
far more profound than regulators assumed in the context of fintech, mostly because nobody
could possibly think of the growing role of fintech in overall financial services industry back then.
I gained most of my understanding of Durbin Amendment from this excellent substack by Tanay
Jaipuria. The implications of Durbin Amendment on Square and other fintech companies are
manifold, as eloquently explained by Jaipuria:
“The higher economics that some of these firms make on a customer relative to what big banks
might make on the same customer has a few major effects:
1. These startups can spend more on acquiring the same customer because the
customer is more valuable to them than to big banks.
2. These startups can profitably serve some customer niches which may be unprofitable
for big banks to go after given the difference in revenue opportunity alone.
3. These startups can make their product more compelling to customers by leveraging
the higher interchange and passing it back to customers in the form of reward programs,
early pay-outs, and other features.
4. These startups can spend more on R&D, customer service on a per-customer
basis relative to big banks, since they can spend more to serve these customers.
In practice, we see a mix of all of these being carried out in some shape or form. Examples include
Square’s cash card using “boosts” and Chime allowing users to receive their paycheck early.”
With ~$150 Bn market cap (SQ+APT), SQ would be bigger than Citigroup and I think it is highly
unlikely that SQ would be able to capitalize on this regulatory loophole for too long. I think
investors need to underwrite SQ today with the assumption that this loophole may not exist
forever. Whatever the market cap, big banks are obviously extremely powerful group in the US
and they will use their weight to nudge regulator in the “right” direction. One suggestion that was
brought up is instead of just considering the partner banks’ assets, regulator should consider both
the issuer and the third party’s aggregate assets to allow the exemption.
While such regulation could certainly be a headwind for SQ stock, I am not sure that it will be
long-term negative for the company. Removing Durbin Amendment would be much more fatal
blow for valuation of fintech startups or Neo or challenger banks and it may even open up more
white space for SQ to grab the market instead of competing with VC funded startups. As of 2Q’21,
SQ has ~$14 Bn assets in its balance sheet and considering its recent banking charter, SQ is
perhaps preparing preemptively to operate under a more restrictive regulatory environment.
Then there is BNPL. Given the nascent stage, it is almost guaranteed to see increasing regulatory
scrutiny going forward if it continues to gain momentum among consumers. While it is difficult to
have a definite prospective opinion on regulatory development, I think APT is the least likely to be
under regulatory pressure given that they don’t have longer term financing product and they don’t
charge interest for the 6-week “loan”.
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As a generalist, I am always a bit uncomfortable about the fact that I may not know what I don’t
know, and it cannot probably get any more uncomfortable than regulations in financial services.
Please keep that in mind as you keep reading the next section.
Section 5: Valuation and model assumptions
If you are reading my deep dive for the first time, I encourage you to read my piece on “approach
to valuation”. I follow an “expectations investing” or reverse DCF approach as I try to figure out
what I need to assume to generate a decent IRR from an investment which in this case to be
~7%. Then I glance through the model and ask myself how comfortable I am with these
assumptions. As always, I encourage you to download the model and build your own narrative
and forecast as you see fit to come to your own conclusion. None of us have the crystal ball to
forecast 5-10 years down the line, but it’s always helpful to figure out what we need to assume to
generate decent return.
Before I discuss the model assumptions, please note that the impact of Afterpay acquisition is
included from 2022 as the acquisition is expected to be completed by 1Q’22. In addition, because
of the volatility of bitcoin trading revenue, bitcoin related impacts are taken out of the assumptions,
and it is more instructive to look at gross profit instead of revenue for SQ. Bitcoin trading revenue
has minimal impact to SQ’s bottom line since it typically generates ~1-2% gross margin and has
<5% contribution to gross profit mix. I will discuss the model in three segments: Seller Ecosystem,
Cash App, and Afterpay. SQ started reporting Seller Ecosystem and Cash App separately from
2018 and we do not have the breakdown by segment before that period.
Seller Ecosystem: Revenue from seller ecosystem can be further segmented into three
categories: transaction-based revenue, subscription and services revenue, and hardware
revenue. SQ deploys Razor and Blade model on hardware and sells hardware at negative gross
margin. Once the hardware in place, SQ’s revenue and profit grow with sellers’ revenue. SQ
started reporting sellers Gross Payment Volume (GPV) and Cash App GPV separately since last
year. In 2020, SQ reported overall GPV of $112.3 Bn of which sellers GPV was $103.7 Bn.
Because of the pandemic, SQ sellers, majority of which are physical SMBs, were
disproportionately affected. GPV increased from $35.6 Bn in 2015 to $106.2 Bn in 2019, implying
31.4% CAGR over this period. For every $100 GPV, SQ makes ~$1.2 Gross Profit. Given the
massive size of SQ’s end markets, GPV growth may not regress as quickly as modeled here. The
flip side of this is category specific competition (e.g. Toast in restaurant) can pose some question
marks for SQ to maintain the growth momentum. Nonetheless, roughly doubling GPV from 2024
to 2030 does not appear aggressive to me. Overall GPV in 1H’21 was $76 Bn, up by 56.5% YoY.
For subscription/services, it includes SQ Capital products as well as other software/subscription
products (e.g. monthly software fees per location for Square for Restaurant). While SQ does not
disclose revenue from SQ Capital, it does disclose how much loan SQ Capital disburses to sellers.
Again, 2020 numbers were impacted by the pandemic. I kept the loans as % GPV around 2-2.2%
going forward and the revenue is calculated assuming 5% spread on the loans. Outstanding loan
of 2% as % GPV can prove conservative since SQ is making inroads to mid and larger sellers
from micro sellers, it is likely SQ can disburse more loans than modeled here and as discussed
in section 1, unless these sellers are not out of business, SQ has first claim on their sales.
25 | P a g e
For other software/services within subscription segment, I expect SQ to introduce more services
for existing seller segments and possibly enter more seller segments in the future. Both those
dynamic should allow them to grow this high margin revenue line.
Hardware, as mentioned earlier, is expected to continue to operate as loss leading segment.
Overall gross margin for seller ecosystem is modeled increase by ~270 bps over the next decade
from 42.7% in 2020 to 45.4% in 2030.
Amount in USD Mn, except % 2018A 2019A 2020A 2021E 2022E 2023E 2024E 2025E 2026E 2027E 2028E 2029E 2030E
Sellers Ecosystem
Net revenue 2,720 3,462 3,529 4,973 6,218 7,477 8,637 9,967 11,186 12,543 13,846 15,288 16,617
Growth 27.3% 1.9% 40.9% 25.0% 20.3% 15.5% 15.4% 12.2% 12.1% 10.4% 10.4% 8.7%
Transaction-based revenue 2,429 3,008 3,061 4,286 5,357 6,429 7,393 8,502 9,522 10,665 11,731 12,904 13,937
Seller GPV 83,191 103,727 103,700 145,180 181,475 217,770 250,436 288,001 322,561 361,268 397,395 437,135 472,105
Growth 24.7% 0.0% 40.0% 25.0% 20.0% 15.0% 15.0% 12.0% 12.0% 10.0% 10.0% 8.0%
As % of GPV 2.92% 2.90% 2.95% 2.95% 2.95% 2.95% 2.95% 2.95% 2.95% 2.95% 2.95% 2.95% 2.95%
Subscription/services revenue 222 369 376 522 679 849 1,028 1,234 1,419 1,622 1,846 2,101 2,383
Growth 66.1% 1.9% 38.8% 30.0% 25.0% 21.2% 20.0% 15.0% 14.3% 13.8% 13.8% 13.4%
SQ Capital
Loans 1,606 2,270 1,830 2,471 3,212 4,015 5,018 6,022 6,925 7,756 8,532 9,385 10,136
Growth 31.4% 41.3% -19.4% 35.0% 30.0% 25.0% 25.0% 20.0% 15.0% 12.0% 10.0% 10.0% 8.0%
As % of GPV 1.93% 2.19% 1.76% 1.70% 1.77% 1.84% 2.00% 2.09% 2.15% 2.15% 2.15% 2.15% 2.15%
Revenue (SQ Capital) 80 114 92 124 161 201 251 301 346 388 427 469 507
Growth 41.3% -19.4% 35.0% 30.0% 25.0% 25.0% 20.0% 15.0% 12.0% 10.0% 10.0% 8.0%
other software products/fees 142 256 285 399 518 648 778 933 1,073 1,234 1,419 1,632 1,877
Growth 80.1% 11.4% 40.0% 30.0% 25.0% 20.0% 20.0% 15.0% 15.0% 15.0% 15.0% 15.0%
Hardware revenue 69 85 92 165 181 200 216 231 245 257 270 283 297
Growth 23.4% 8.5% 80.0% 10.0% 10.0% 8.0% 7.0% 6.0% 5.0% 5.0% 5.0% 5.0%
Cost of revenue 1,647 2,072 2,021 2,888 3,573 4,261 4,884 5,594 6,246 6,972 7,655 8,406 9,076
Transaction related costs 1,530 1,895 1,837 2,571 3,214 3,857 4,436 5,101 5,713 6,399 7,039 7,743 8,362
As % of related revenue 63.0% 63.0% 60.0% 60.0% 60.0% 60.0% 60.0% 60.0% 60.0% 60.0% 60.0% 60.0% 60.0%
As % of GPV 1.84% 1.83% 1.77% 1.77% 1.77% 1.77% 1.77% 1.77% 1.77% 1.77% 1.77% 1.77% 1.77%
Subscription/services costs 23 40 41 52 68 85 103 123 142 162 185 210 238
Hardware costs 94 136 144 264 290 319 345 369 391 411 431 453 476
As % of related revenue 137% 161% 157% 160.0% 160.0% 160.0% 160.0% 160.0% 160.0% 160.0% 160.0% 160.0% 160.0%
Gross Profit 1,072 1,390 1,508 2,085 2,645 3,215 3,753 4,373 4,939 5,571 6,192 6,883 7,541
Gross margin 39.4% 40.2% 42.7% 41.9% 42.5% 43.0% 43.5% 43.9% 44.2% 44.4% 44.7% 45.0% 45.4%
Transaction Gross Profit 899 1,113 1,224 1,714 2,143 2,571 2,957 3,401 3,809 4,266 4,692 5,162 5,575
Subscription/services Gross Profit 199 329 336 470 611 764 926 1,111 1,277 1,460 1,661 1,891 2,145
Hardware Gross Profit (26) (52) (52) (99) (109) (120) (129) (138) (147) (154) (162) (170) (178)
Cash App: Revenue from Cash App can be further segmented in three categories: transaction-
based revenue, subscription and services revenue, and bitcoin revenue. Since 2020, SQ started
reporting both overall GPV and seller GPV and the difference between the two is Cash App
Business GPV which includes Cash for Business, and peer-to-peer payments sent from a credit
card.
Transaction revenue in Cash App is derived from either closed loop payment volume or credit
card loads to Cash App. As explained earlier, when fund is transferred from a customer’s Cash
App wallet to seller’s Cash App for business, SQ keeps the whole pie and technically it costs SQ
nothing (it’s just moving 1s and 0s on SQ’s servers to credit one account and debit the other), so
it is an extremely high margin business. But if Cash App GPV comes from credit card, it is
tantamount to accepting credit card on the merchant side. We do not know how much of the Cash
App GPV is coming from these two mixes, but given SQ’s ultimate mission to promote closed
loop, I have incrementally increased gross margin of transaction revenue assuming that over time,
more and more users will be utilizing their wallet directly to pay for products/services.
26 | P a g e
However, as explained earlier in section 2, closed loop system will have an opposite effect on
interchange fees and instant deposit fees which contribute almost all of the subscription/service
gross profits. If Cash App Wallet becomes the de facto banking account for users, they won’t need
to use instant deposit service anymore. Moreover, if Durbin amendment is repealed, interchange
fees will be under pressure and SQ will earn ~20 bps per $100 transaction. However, it is very,
very difficult to model these dynamics appropriately given lack of disclosure and regulatory
uncertainty. There are close bull/bear debates here. Bulls would probably argue my ARPU
estimates (assuming no growth in ARPU from 2021-2030) are just too low (e.g. ARK estimates
average ARPU for active digital customer in JP Morgan, Wells Fargo, and Bank of America is
~$880 per year). But there are a lot of moving pieces here. A lot of the revenue is essentially
shifting from subscription/services to transaction revenue as more and more payment is expected
to take place in the closed loop payment which will eliminate interchange fees and instant deposit
fees.
Bears may argue if you take out the two largest profit generators of subscription/services in Cash
App, ARPU projections for this segment is perhaps overstated. Moreover, Given the assumption
of 167 mn Cash App MAU, it is implied that Cash App will become very mainstream. But if higher
income users who may not need to use the service such as instant deposit or use the App for any
other service other than peer-to-peer payments, ARPU can prove to be too optimistic. The tricky
part is we do not know what other use cases Cash App may add in the future which can be
potential source for revenue/gross profit down the line. Therefore, modeling Cash App is a very
challenging exercise given all the moving and unknown pieces.
Let me remind you again the objective of my valuation exercise is not to forecast/predict, but to
build an expectations-based model. In some cases, it can be difficult to come to a concrete
conclusion on the expectations, but I hopefully I am not too aggressive here.
I doubled 1H’21 bitcoin trading revenue for FY’21, but only assumed ~30% of that revenue in
2022. Following 2022, I just assumed 10% revenue growth from bitcoin trading going forward.
Given it’s ~2% gross margin business, these estimates are mostly noise.
27 | P a g e
Cash App
Net revenue 430 1,106 5,968 14,564 7,267 8,910 10,495 11,998 13,445 14,894 16,374 17,848 19,211
Growth 157.1% 439.8% 144.0% -50.1% 22.6% 17.8% 14.3% 12.1% 10.8% 9.9% 9.0% 7.6%
Transaction-based revenue 43 73 234 514 823 1,152 1,497 1,872 2,246 2,651 3,048 3,414 3,755
As % of total txn based revenue 1.7% 2.4% 7.1% 10.7% 13.3% 15.2% 16.8% 18.0% 19.1% 19.9% 20.6% 20.9% 21.2%
Cash App GPV 8,595 18,909 30,254 42,356 55,063 68,829 82,595 97,462 112,081 125,530 138,083
As % of SQ GPV 7.7% 11.5% 14.3% 16.3% 18.0% 19.3% 20.4% 21.2% 22.0% 22.3% 22.6%
Growth 120.0% 60.0% 40.0% 30.0% 25.0% 20.0% 18.0% 15.0% 12.0% 10.0%
As % of GPV 2.72% 2.72% 2.72% 2.72% 2.72% 2.72% 2.72% 2.72% 2.72% 2.72% 2.72%
Subscription/services revenue 221 516 1,163 2,050 2,844 3,798 4,642 5,334 5,928 6,445 6,948 7,419 7,739
MAU 15 24 36 49 63 79 95 109 122 134 148 160 167
Growth 114.3% 60.0% 50.0% 35.0% 30.0% 25.0% 20.0% 15.0% 12.0% 10.0% 10.0% 8.0% 5.0%
ARPU 20.1 26.5 38.8 48 51 53 53 52 51 50 49 48 47
Growth 31.9% 46.4% 25.0% 5.0% 5.0% 0.0% -2.0% -2.0% -2.0% -2.0% -2.0% -2.0%
Bitcoin revenue 167 516 4,572 12,000 3,600 3,960 4,356 4,792 5,271 5,798 6,378 7,015 7,717
Cost of revenue 235 648 4,743 12,222 4,186 4,751 5,326 5,910 6,507 7,129 7,784 8,470 9,179
Transaction related costs 28 43 75 155 231 301 361 414 452 481 492 482 456
Subscription/service related costs 42 97 193 307 427 570 696 800 889 967 1,042 1,113 1,161
Costs per MAU, excl. bitcoin 7.16 8.94 10.93 11.77 12.25 12.17 11.92 11.61 11.29 10.88 10.39 9.89
Bitcoin related costs 165 508 4,475 11,760 3,528 3,881 4,269 4,696 5,165 5,682 6,250 6,875 7,563
Gross Profit 195 458 1,226 2,342 3,081 4,158 5,169 6,088 6,938 7,764 8,590 9,377 10,032
Gross Profit per MAU 23.5 40.9 55.4 55.1 58.5 59.5 59.8 60.1 60.6 60.9 61.0 61.4
Gross margin 45.3% 41.4% 20.5% 16.1% 42.4% 46.7% 49.2% 50.7% 51.6% 52.1% 52.5% 52.5% 52.2%
Gross margin, excl. bitcoin 73.3% 76.3% 80.8% 82.0% 82.1% 82.4% 82.8% 83.1% 83.6% 84.1% 84.7% 85.3% 85.9%
Transaction Gross Profit 14 30 159 359 591 851 1,136 1,458 1,794 2,170 2,556 2,931 3,300
Subscription/services Gross Profit 179 419 970 1,742 2,417 3,228 3,945 4,534 5,039 5,478 5,906 6,306 6,578
Hardware Gross Profit 2 8 97 240 72 79 87 96 105 116 128 140 154
For costs, I assumed some scale benefits for R&D and SG&A as the revenue grows over time.
Transaction and loan losses consist of loan losses from SQ Capital loans, and transaction losses
due to chargebacks etc. While SQ does not disclose these two losses separately, it did mention
loan losses from SQ Capital is trending below 4% (and going down over time) on its investor day
last year. I kept 3.6% loan loss ratio at constant which can prove to be a bit conservative during
good times given SQ is moving to larger sellers these days, but at the same time, during any
recession loan loss ratio can shoot up. Perhaps over the course of the whole cycle, ~3.5-4% will
prove to be a reasonable approximation.
SQ specific expenses
Product development 497 671 882 1,196 1,586 1,907 2,319 2,742 3,138 3,515 3,891 4,251 4,524
As % of revenue, excl. bitcoin 15.9% 16.0% 17.9% 16.0% 15.8% 15.6% 15.4% 15.2% 15.0% 14.8% 14.6% 14.4% 14.2%
Sales & Marketing 411 625 1,110 1,720 2,309 2,689 3,162 3,607 4,183 4,750 5,331 5,904 6,372
Return on incremental S&M 5.8x 5.0x 1.5x 4.2x 7.6x 7.7x 7.7x 8.6x 6.6x 6.6x 6.6x 6.7x 7.4x
General & Administrative 339 436 579 748 1,004 1,222 1,506 1,804 2,092 2,375 2,665 2,952 3,186
Transaction and loan losses 88 127 178 159 207 257 311 362 404 442 481 515 540
Loan losses % 3.8% 3.7% 3.6% 3.6% 3.6% 3.6% 3.6% 3.6% 3.6% 3.6% 3.6% 3.6% 3.6%
Loan losses $ 54 72 74 77 102 130 163 194 218 240 264 283 298
Transaction losses 34 55 104 82 105 127 148 168 186 202 217 231 243
As % of GPV 0.04% 0.05% 0.09% 0.05% 0.05% 0.05% 0.05% 0.05% 0.05% 0.05% 0.05% 0.05% 0.05%
Amortization of acquired assets 4 4 4 5 5 5 5 5 5 5 5 5 5

As % of intangibles 9.5% 6.1% 3.7% 3.5% 3.5% 3.5% 3.5% 3.5% 3.5% 3.5% 3.5% 3.5% 3.5%
Afterpay: I have modeled APT’s income statement separately and then included APT’s numbers
in the overall SQ statements from 2022. APT’s fiscal year ends in June, but to keep things simple,
I just assumed fiscal year to be the same as SQ. So what you see under the column year 2020,
APT reported these numbers in FY’2021 (July-June). Moreover, since APT reports its financials
in AUD, I have converted these numbers in USD by uniformly multiplying the historical numbers
by 0.75. Once APT acquisition is complete next year, you will have to make these adjustments in
the model if you want to update later.
28 | P a g e
Since APT started its journey in Australia, following their trajectory in APAC can be helpful to
understand how it may pan out in North America. While North America’s GMV increased ~10x
from $696 mn in 2018 to $7.4 Bn in 2020, GMV per active customer is still less than half of
APAC’s. Given the much faster growth in active customers in North America, it may have a much
longer runway than APAC in terms of GMV/Active customer. While I modeled $1,918 GMV/active
customer in North America in 2030, this is likely conservative given APAC may reach ~$3.6k
GMV/active customer by that time. Although APT’s active customer base today accounts for 45%
of Cash App MAU, I modeled it to reach ~55% by 2030. Can it be ~75-80% of Cash App MAU in
10 years? It’s hard to rule out such a possibility once APT is integrated directly to Cash App.
For revenue, I gradually increased take rates by 10 bps in each of the next 10 years. Again, I do
believe as Cash App and APT scale its user base, it will gain significant leverage over small/mid
or even some large brands to negotiate higher take rates. They are just not payment providers,
rather they are going to provide traffic to those websites that will lead to more sales. It’s likely that
those brands will pay much higher than credit card rates for such a deal. Even 5-6% take rate
could prove to be on the conservative side in 10 years if APT can continue to drive higher sales
for those brands.
While APT has faced scrutiny for late fees in the past, I hope the model shows to you that even if
those late fees get banned, we really don’t need to be concerned. One of my concerns is if there
is a significant regulatory scrutiny takes place in BNPL segment and regulator takes a heavy-
handed approach for all types of BNPL. As explained earlier, unlike other BNPLs, APT makes
zero dollar from interest income from the consumers. So theoretically they should be clear from
the scrutiny that is highly likely to take place for companies that are making loans to consumers
without much credit checks. But it is hard to know how regulation evolves and whether APT
becomes a collateral damage in an increased regulatory scrutiny environment.
While APT typically incurs ~1% loan loss ratio as % of GMV, because of the low take rates it leads
~20% of revenue. Of course, in a recessionary environment, it is very likely that there will be an
uptick in loan loss ratio. I have doubled the loan loss ratio i.e. ~40% of revenue randomly in 2025
and 2028 just to incorporate this dynamic. I obviously don’t know when the economic recession
or slowdown will happen and how bad things will get when it happens, but still wanted to model
this assumption somewhere along the line in the forecasts. Increasing take rate is critically
important for APT; while just 2% of GMV loan loss ratio leads to loss of a whopping ~40% revenue,
if the take rate were 5-6%, the loan losses become more manageable during difficult times.
Overall, I think the APT acquisition can be a potential gamechanger for both SQ and APT. Even
in this somewhat conservative modeling scenario, APT will have ~31% gross profit contribution
to SQ in 2030. But if APT manages to increase take rates even more than 5%, APT’s significance
to SQ will be even more material.
29 | P a g e
Afterpay
GMV 3,935 8,336 15,815 24,501 36,393 50,693 65,849 82,443 100,275 117,899 135,268 153,913 175,282
$ GMV growth 2,297 4,400 7,480 8,685 11,892 14,300 15,155 16,595 17,832 17,624 17,369 18,645 21,368
Growth 140.2% 111.8% 89.7% 54.9% 48.5% 39.3% 29.9% 25.2% 21.6% 17.6% 14.7% 13.8% 13.9%
APAC 3,236 4,925 7,085 8,336 9,628 10,812 11,857 12,820 13,730 14,565 15,302 15,920 16,563
GMV/active customer 1,615 2,054 2,259 2,485 2,684 2,872 3,044 3,196 3,324 3,424 3,492 3,562
Growth 27.2% 10.0% 10.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 2.0%
North America 696 2,993 7,364 13,736 23,245 35,286 48,465 63,392 79,675 95,760 111,656 128,963 148,952
GMV/active customer 809 915 1,006 1,107 1,218 1,315 1,420 1,534 1,641 1,740 1,827 1,918
Growth 13.1% 10.0% 10.0% 10.0% 8.0% 8.0% 8.0% 7.0% 6.0% 5.0% 5.0%
Clearpay 4 418 1,366 2,429 3,520 4,595 5,527 6,232 6,870 7,575 8,310 9,030 9,766
GMV/active customer 836 881 925 972 1,020 1,071 1,125 1,181 1,240 1,302 1,367 1,436
Growth 5.5% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0%
Active Customers 4.6 9.9 16.2 23.7 33.3 41.8 50.5 58.2 65.9 71.8 78.3 85.3 93.0
Growth 130.0% 115.2% 63.6% 46.5% 40.2% 25.5% 21.0% 15.3% 13.1% 9.0% 9.0% 9.0% 9.0%
As % CashApp MAU 30.7% 41.3% 45.0% 48.8% 52.6% 52.9% 53.3% 53.4% 54.0% 53.5% 53.0% 53.5% 55.5%
APAC 2.8 3.3 3.6 3.78 3.97 4.09 4.17 4.25 4.34 4.43 4.51 4.60 4.70
Growth 17.9% 9.1% 5.0% 5.0% 3.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0% 2.0%
North America 1.8 5.6 10.5 16.8 25.2 32.8 41.0 48.3 55.6 61.1 67.2 74.0 81.4
Growth 211.1% 87.5% 60.0% 50.0% 30.0% 25.0% 18.0% 15.0% 10.0% 10.0% 10.0% 10.0%
Clearpay - 1.0 2.1 3.2 4.1 4.9 5.4 5.7 6.0 6.3 6.5 6.7 6.9
Growth 110% 50.0% 30.0% 20.0% 10.0% 5.0% 5.0% 5.0% 4.0% 3.0% 3.0%
Active Merchants 32.2 55.4 98.2

Growth 101.3% 72.0% 77.3%
APAC 28.4 42.8 63.1
North America 3.8 11.5 28.4
Clearpay - 1.1 6.7
APT revenue 151 325 617 980 1,492 2,129 2,831 3,627 4,512 5,423 6,357 7,387 8,588
As % of GMV 3.83% 3.90% 3.90% 4.0% 4.1% 4.2% 4.3% 4.4% 4.5% 4.6% 4.7% 4.8% 4.9%
Pay Now revenue 13 12 10 12 15 15 13 8 10 12 14 15 18
As % of GMV 0.33% 0.15% 0.07% 0.05% 0.04% 0.03% 0.02% 0.01% 0.01% 0.01% 0.01% 0.01% 0.01%
Other revenue(late fees) 35 52 66 91 117 137 145 140 121 142 163 185 211
As % of GMV 0.88% 0.62% 0.42% 0.37% 0.32% 0.27% 0.22% 0.17% 0.12% 0.12% 0.12% 0.12% 0.12%
APT total revenue 198 389 694 1,083 1,623 2,281 2,989 3,776 4,643 5,576 6,533 7,588 8,816
ARPU 54 53 54 57 61 65 69 75 81 87 93 99
Cost of sales 45 101 187 289 429 598 777 973 1,183 1,391 1,596 1,816 2,068
As % of revenue 22.5% 25.9% 27.0% 26.7% 26.5% 26.2% 26.0% 25.8% 25.5% 24.9% 24.4% 23.9% 23.5%
As % of GMV 1.14% 1.21% 1.18% 1.18% 1.18% 1.18% 1.18% 1.18% 1.18% 1.18% 1.18% 1.18% 1.18%
Gross Profit 153 289 506 794 1,194 1,683 2,212 2,803 3,459 4,185 4,937 5,771 6,748
Gross Margin 77.5% 74.1% 73.0% 73.3% 73.5% 73.8% 74.0% 74.2% 74.5% 75.1% 75.6% 76.1% 76.5%
D&A 17 23 29 41 55 69 78 84 103 124 145 168 195
As % of revenue 8.5% 5.8% 4.2% 3.8% 3.4% 3.0% 2.6% 2.2% 2.2% 2.2% 2.2% 2.2% 2.2%
Employment expenses 39 65 113 171 249 338 428 522 618 715 805 897 998
As % of revenue 19.5% 16.6% 16.3% 15.8% 15.3% 14.8% 14.3% 13.8% 13.3% 12.8% 12.3% 11.8% 11.3%
SBC 23 23 44 65 97 137 179 227 279 335 392 455 529
As % of revenue 11.6% 5.9% 6.4% 6.0% 6.0% 6.0% 6.0% 6.0% 6.0% 6.0% 6.0% 6.0% 6.0%
Receivables impairment expenses 44 71 146 221 328 456 593 1,484 902 1,061 2,435 1,385 1,578
As % of revenue 22.2% 18.2% 21.1% 20.4% 20.2% 20.0% 19.8% 39.3% 19.4% 19.0% 37.3% 18.3% 17.9%
As % of GMV 1.12% 0.85% 0.92% 0.90% 0.90% 0.90% 0.90% 1.8% 0.9% 0.9% 1.8% 0.9% 0.9%
Net loss on financial liabilities at fair value - 1 73
Operating expense 55 110 224 325 454 593 747 906 1,068 1,227 1,372 1,518 1,763
As % of revenue 27.7% 28.2% 32.3% 30.0% 28.0% 26.0% 25.0% 24.0% 23.0% 22.0% 21.0% 20.0% 20.0%
Operating Profit (24) (3) (123) (29) 10 90 187 (419) 489 724 (211) 1,348 1,685
Operating margin -12.0% -0.9% -17.8% -2.7% 0.6% 3.9% 6.2% -11.1% 10.5% 13.0% -3.2% 17.8% 19.1%
Valuation: To generate ~7% IRR, I needed to use 30x terminal FCF multiple. Please note I have
issued ~107 mn SQ shares to acquire APT in 2022 and hence there is a material rise in diluted
number of shares outstanding in 2022. I kept the cash balance at $3-4 Bn and utilized the rest of
the FCF to buyback shares. I also set aside $1.5 Bn each year from 2023-2030 for acquisitions.
If you make changes in model, keep an eye on the cash balance and make sure you are not just
letting the cash pile up in balance sheet without offsetting it through buybacks. It is possible that
SQ will deploy a lot of the FCF to acquire companies rather than buying back shares. Finally, I
would like to mention one more aspect that is not reflected in FCF, but nonetheless can become
material over the long run. Since SQ has the discretion to use customer funds kept in Cash App
to purchase short-term marketable debt securities, they will earn some spread on that customer
fund. Currently, this positive spread on customer balance is uncaptured in OCF and this dynamic
shows up in investing activities in cash flow statement. This effectively understates the OCF (and
hence FCF) if we consider SQ to be operating like a "bank" in which case using customer funds
to earn a positive spread should be under OCF. While today it is not a material omission, over
time if SQ indeed becomes more and more like a bank, this may need to be considered to better
reflect the true FCF potential of the company.
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Items 2020A 2021E 2022E 2023E 2024E 2025E 2026E 2027E 2028E 2029E 2030E
OCF 382 735 2,137 2,856 3,886 3,793 6,061 7,225 6,564 9,891 11,262
Capex (138) (166) (253) (324) (391) (461) (528) (599) (668) (742) (812)
FCF 243 569 1,883 2,533 3,495 3,332 5,533 6,626 5,895 9,149 10,450
FCF/share 0.5 1.1 3.1 4.0 5.5 5.1 8.3 9.9 8.7 13.5 15.4
Terminal FCF multiple 30.0x
Terminal Stock price 463
Current price* 247.1
Dividend/share - - - - - - - - - - -
Cash flow (247) - - - - - - - - 463
IRR 7.2%
#diluted shares outstanding 482 499 615 627 640 655 664 669 675 679 678
*Closing price of September 14, 2021
Stock price 247 265 284 304 326 350 375 402 431 462 495
Section 6: Management and Incentives
Jack Dorsey is perhaps a polarizing figure among my readers for a lot of reasons. I too have
mixed feelings about him. In June this year, Dorsey said this in Bitcoin 2021 conference: “I don’t
think there is anything more important in my lifetime to work on.” This is remarkable given Dorsey
has the burden of leading two public companies (Twitter, and Square) and yet he thought it was
something else that has precedence over either of those companies. Leading two companies
simultaneously is nothing unheard of. Steve Jobs did it before (Apple and Pixar) and Elon Musk
(Tesla and SpaceX) does it today as well, but it is comment like that makes me a bit uncomfortable
about Dorsey. Therefore, before I studied him closely for this deep dive, I started from a vantage
point of skepticism about Dorsey as CEO. However, after doing more digging, I believe the
positives outweigh the potential concerns one may have on Dorsey.
While it is easy to dismiss Dorsey as an eccentric CEO with tattoo and nose ring, I wonder whether
that’s just first-level reaction. Dorsey is far from an insider in the tech world. Who is Jack Dorsey?
He was born and brought up in St Louis Missouri. While both of his parents were entrepreneurs,
they were both small business owners. Dorsey started playing with computer from an early age
and started working on dispatch network when he was a teen. When he was in high school, he
worked for Jim McKelvey, the other co-founder of Square, and Dorsey left such a strong
impression that they ended up working and building Square together when Jack went back to
Missouri after being ousted from Twitter. Although Jack started college in University of Missouri,
he dropped out two years later and moved to NYC to work on a dispatch company there. At his
parents’ request, he started college again at NYU, but just one semester prior to graduation, he
dropped out again and moved to California to work for a dispatching company. He was fired from
the company in 2002 after bickering with board members and went back to Missouri. Three years
later, he moved back to San Francisco and found a short-term coding gig on Craiglist in 2005. He
also did babysit in exchange for room and board and lived in a shed. In 2005, Dorsey was 29-
year-old, was in debt and struggling to pay rent, and yet 15 years later, he is worth $15 Bn after
founding two iconic American companies. I am very hesitant to nurture any deep aversion for a
man with such resilience, endurance, and execution.
Dorsey came up with the prototype of twitter in two weeks. Long story short, he later was fired
from Twitter for, well, being eccentric. When he went back to Missouri, Dorsey was a bit wayward,
thinking about being a massage therapist to fashion designer. Time Magazine did an issue at that
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time highlighting 100 most influential people in the world. The issue highlighted the other two co-
founders of Twitter, but it did not even mention Dorsey. Dorsey eventually became CEO of Twitter
in 2015.
I mention all these details to point out Dorsey’s very modest background, history of mercurial
character, and how cornered he was before he founded Square. Square came to IPO at just ~$2.9
Bn valuation in November 2015 whereas Twitter was valued at ~$15 Bn at IPO in November 2013
(and $~25 Bn after the first day of trading). Today, Square is valued $120 Bn whereas Twitter’s
market cap is ~$50 Bn.
After Covid happened, Dorsey announced to give away $1 Bn worth of SQ shares (now worth
~$4 Bn) which was ~28% of his wealth to charity. He created a public Google Sheet to make it
transparent how the amount is being donated. So far, he has given away $423 Mn, so more than
$3.7 Bn remains unutilized. Not only Dorsey is charitable, he seems to be more than willing to
acknowledge others who contribute to create value in his companies. One of the things I really
liked about Dorsey is that he points out TWTR and SQ had multiple “founding moments”. These
companies have changed dramatically since they were originally founded, and Dorsey believes
more people should be celebrated for each of those founding moments. He seems very willing to
deemphasize his presence in any of the two companies he leads today.
When I think about Dorsey’s life trajectory, I can understand how he can be both genius and naive
simultaneously and it is fundamentally difficult to differentiate between the two in real time. I can
understand the appeal he may have for a single global currency. If the world indeed had just one
currency, of course that would make life easier, but of course financial markets and payments are
regulated for very good reasons. Dorsey repeatedly mentions one of his favorite quotes by William
Gibson, "The future is already here — it's just not very evenly distributed." So I understand his
deep desire for something like bitcoin to be adopted by the wider world even if I do not find it
convincing. I am aware of the Halo Effect, but I personally made a conscious decision to be open
to eccentric characters and not just brush them off from my ivory tower of “normalcy”.
Let’s talk about incentives now. Dorsey takes a base salary of $2.75 from SQ and $1.4 from
TWTR (no typo or zero missing). He receives zero bonus, stock awards, or options. He is,
however, more than adequately aligned with shareholders as he owns ~10% of SQ and ~48%
voting power. Jim McKelvey, the other co-founder, owns ~3% of SQ and ~13% of voting power
although he does not work at SQ anymore but sits at the board.
Base pay for Named Executive Officers (NEO) is $475k. Interestingly, base pay for TWTR NEOs
is $600k. However, total compensation for NEOs in both the companies usually hovered between
$6-8 Mn per year. SQ seems to approach compensation very differently than TWTR. While TWTR
has two specific metrics to track performance (GAAP revenue and adjusted EBITDA), I could not
find any operating metric for SQ to track incentives. Given how dynamic payment market is today,
perhaps it is not a bad thing that SQ is not optimizing for metrics today.
Section 7: Final words
I took a ~5% position at SQ. While the stock became more than 6x from Covid lows, I believe the
business is fundamentally much better positioned than ever before. Mr. Market is not oblivious to
that, but the opportunity ahead of SQ remains compelling enough for me to take a position. Given
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that I do not manage a fixed pool of asset rather a growing pool of savings that are consistently
added to my portfolio, I feel no urge to try to time the market, especially given that I am just 30-
year-old. Writing a deep dive is really an introduction for me to the business which allows me to
understand the company reasonably well, but it takes more time to build a conviction over time
especially when the company operates in a very dynamic space in which the competitive moats
are far from settled. Considering such conviction arises after following SQ more closely over time,
I will increase weight to my portfolio later.
Please note that these are NOT my recommendation to buy/sell these securities, but just
disclosure from my end so that you can assess potential biases that I may have because of my
own personal portfolio holdings. Always consider my write-up as my personal investing journal
and never forget my objectives, risk tolerance, and constraints may have no resemblance to
yours.
Portfolio Discussion: This deep dive has become more than 30-page piece, so I will keep the
portfolio discussion really short this month. I have added a little to my ADSK position following the
recent correction as market, I believe, has overreacted to FY’24 FCF decline guidance and
overlooked the guidance of double digit FCF CAGR from FY’23-26. You can read my twitter
threads on ADSK, LULU, and ETSY since last deep dive.
My current portfolio is disclosed below:
Current Unrealized First First Buy Last Last Buy

Ticker Avg. Cost Weight* Gain % Bought Price Bought Price
ETSY 128.7 17.0% 66.6% Sep'20 111.0 May'21 169.0
BRK.B 197.3 15.3% 40.5% Aug'19 199.7 Mar'21 261.9
FB 224.9 14.7% 67.4% Aug'18 172.8 May'21 326.8
IAC 106.2 14.0% 24.8% Jul'20 83.0 Aug'21 129.7
ADSK 289.4 12.7% -3.5% Feb'21 301.3 Sep'21 288.1
AMZN 2,771.2 6.7% 24.5% Feb'20 1,820.0 Jun'21 3,210.9
GOOG 1,696.2 5.6% 69.1% May'19 1,150.2 Aug'21 2,719.4
LULU 342.5 4.6% 22.8% Jun'21 337.9 Jun'21 347.6
SQ 263.3 4.5% -6.2% Sep'21 271.3 Sep'21 242.2
ANSS 364.0 2.4% 1.4% Dec'20 364.0 Dec'20 364.0
ANGI 11.7 2.3% 0.3% Nov'20 11.7 Nov'20 11.7
Cash 0.1%
Total 100% 35.0%
*Based on prices as of September 14, 2021 (time-weighted YTD: +18.7%); Since inception
(August 24, 2018) time-weighted annualized return +24.8%
I encourage you to subscribe for the annual plan; annual subscribers receive the full schedule of
deep dives in 2021. It will mean a lot if you encourage your colleagues/acquaintances to subscribe
to my work. Your support is deeply appreciated. Thank you so much.
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Recommended readings
1. Articles on Jack Dorsey: New Yorker (2013), Not Boring (2021)
2. Selected talks/podcast by Jack Dorsey: Stanford (2013), Lex Fridman (2021)
3. Jim McKelvey’s book on Square. A good quick review here.
4. Good background read on payfac
5. Interesting piece on Cash App’s early days
6. Net Interest on Square
7. Tanay Jaipuria on Durbin Amendment
8. Articles on Afterpay acquisition (Stratechery, Net Interest, Pymnts.com)
9. Hayden Capital’s pitch on Afterpay
10. The Generalist dissecting Affirm’s S-1 (helpful read to understand BNPL more)
11. ARK Invest on Cash App vs Venmo, Square valuation
Disclaimer: All posts on “MBI Deep Dives” are for informational purposes only. This is NOT a
recommendation to buy or sell securities discussed. Please do your own work before investing
your money.
34 | P a g e

SQ Deep Dive 1

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MBI Deep Dives | September 2021

Square: The quest for an inclusive financial ecosystem

Section 1: The Seller Ecosystem

Source: Clearly Payments

Product Pricing/features Transaction- Subscription Hardware

Square for $60/month/location ✓ ✓

Section 2: The Cash App

Section 3 APT: Quasi-marketplace masquerading as BNPL

Monthly Web/mobile traffic in the US

Afterpay Klarna Affirm

Monthly Global web/mobile traffic, ex-US

Section 4: Regulatory arbitrage and potential headwind

Section 5: Valuation and model assumptions

Amortization of acquired assets 4 4 4 5 5 5 5 5 5 5 5 5 5

Active Merchants 32.2 55.4 98.2

Section 6: Management and Incentives

Section 7: Final words

Current Unrealized First First Buy Last Last Buy

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