- Square, an e-payments company, went public last week in a successful market debut.
- The heavy discount on Square’s IPO price drove an impressive first-day hike, but the trend quickly changed, and the stock is already down 7%.
- The market is currently too crowded for Square to grow and remain competitive.
The long-awaited Square IPO took place last week, attracting a lot of attention from the tech and financial sectors. The company is led by Jack Dorsey, the CEO of Twitter (NYSE:TWTR). Square is a high-profile payment processing unicorn that was valuated on the private market at $6 billion. The company has faced a negative sentiment since it filed for IPO. This negative sentiment was caused by the correction in the markets and the mutual funds private investments revaluation, as described in an earlier article about the upcoming burst of the private valuations bubble.
To tackle the negative sentiment and drive higher demand, Square substantially discounted its IPO price compared to the latest series E funding round that took place last year. As shown in Chart 1 below, Square’s initial IPO price was almost 50% lower than the E series price that immediately attracted a lot of attention and drove the opening price 23% higher to $11 on the IPO day.
After the opening bell, Square stock price rose to $14.78 before settling at $13.06, which reflected a 45% return on the first day of trading and a $4.2B market cap. Even though Square had not reached the series E price during the first day of trading, the IPO was very successful compared with the pessimistic estimations in the market. However, since the first day pop, Square stock price has already corrected by 7%, and it is now only 35% above its initial IPO price, which reflects an even smaller market cap of $3.9B for the once $6B company.
Square IPO attracted much attention from both the tech and financial sectors, which wanted to see how the market reacts to a beaten-down unicorn IPO during a correction period in the public markets. Financial institutions can be fairly satisfied with the outcome. First, early investors in Square were protected by a ratchet mechanism that guaranteed them a 20% upside above the series E price. Second, investment firms could buy Square’s shares relatively cheap and sell them to the public at the opening price of $11, while price remains significantly lower than the latest funding round. For financial institutions and investment firms, Square's IPO indicated that future unicorn IPOs could also be profitable, as long as the discount is deep enough and early investors are protected.
On the other side, potential tech IPO candidates should understand that the market expects massive discounts on the IPO price compared to the higher valuations in the private markets. The process that started with the disappointing debuts of Box (NYSE:BOX) and PURE STORAGE (NYSE:PSTG) continued with the re-evaluation of Fidelity’s Snapchat and Blackrock’s Dropbox. This will likely end up chilling down the private market valuation bubble.
I believe that the correction which started a day after Square’s IPO will continue for a while, partially because the negative sentiment towards the tech unicorns continues and partially because of the development of the e-payments market. Paypal Holdings (NASDAQ:PYPL) is dominating almost 50% of the market, and PayPal's subsidiaries Braintree and BillMeLater are in the final stages of closing the Xoom deal that will allow PayPal to accelerate its global adoption. New services from Apple (NASDAQ:AAPL), Alphabet Inc-C (NASDAQ:GOOG), and Samsung Electronics (OTC:SSNLF) challenge Square from one side, while new services from JP Morgan Chase (NYSE:JPM), Visa (NYSE:V), American Express (NYSE:AXP), and Mastercard (NYSE:MA) challenge Square from another side. It is unlikely that Square will be able to grow further organically, and I don’t believe it could acquire one of the smaller companies (like Stripe, for example). The bullish case for Square is an acquisition by Apple, Samsung, or even PayPal that would lead to a takeover of Square's market share. Currently, it looks like a weak argument to justify a long position. For the time being, I believe investors should avoid Square stock.