- Square IPO is expected to take place in 2015.
- Square has increased transactions and net revenues year-over-year together with its valuation.
- Expected P/S ratio and price range is on par with data analytics players.
- Square’s great potential lies in its aggregated data that could be used to drive meaningful insights.
Long awaited Square IPO is expected to take place this year and join other exciting tech IPOs in 2015 such as Pinterest IPO and Dropbox IPO. Square is an electronic payment service that was founded by Twitter’s co-founder Jack Dorsey. The company revolutionized the electronic payment market when it enabled small business to accept credit and debit cards transactions on top of their traditional cash transactions. At first, Square targeted mainly food trucks, beauty parlors and other similar cash-based businesses and offered them to process credit and debit card using a dedicated iOS app for relatively small costs. Square expanded its offering beyond small, cash-based businesses and now allows many retailers to accept credit and debit cards payments in a simple, sleek way that enable the business owner to track every transaction in real time.
Small businesses can easily use Square either by its iPad-based point of sale (POS) or a smartphone dongle. Square allows small business owners to avoid interacting with credit cards companies and consolidates all their card based transactions through a single point of contact, Square. This simple service helps small business to save time and costs on financial services that usually are annoying overheads for these businesses. Also, with Square, small businesses can track all transactions in real time, analyze them, and use these insights to improve their operations.
In August 2014, Square acquired food delivery service Caviar for $90 million to boost its restaurant food ordering business started with Square Order. Caviar allows its users to join different orders into a single order from the same restaurant, simplifying the lunch order ritual in many companies. This acquisition is a response to PayPal’s and Amazon’s register solutions that compete directly with Square and offer better transaction fees. Square's advantage over Amazon and PayPal is that Square does not offer an e-commerce platform that theoretically competes with small merchants and is thus not perceived as a possible competitor by small businesses.
Square's business model is based on keeping the transaction fees Square charges its users higher than the transaction costs it pays credit card companies. This gap between the gross transaction revenues and the card's transaction costs is Square’s net revenues. Even though Square’s revenues or credit card transaction terms are not yet disclosed, its revenue trend can be estimated using its annual transaction figures as released in interviews, events, and social media posts together with publicly known credit card transaction costs for retailers. These are the assumptions used to create the net revenues model presented below:
- Square swipe transaction fee is 2.75%, and manual keyed-in transaction fee is 3.5%.
- Manual transactions are 5% of all card transactions.
- Transaction costs charged by all credit card companies are similar to the Visa Intermediate Fees published on October 2014.
- “Best” scenario assumes average Visa transaction cost of 1.5%.
- “Worst” scenario assumes average Visa transaction cost of 2.3%.
- “Mean” scenario is the arithmetic average of two scenarios mentioned above.
- All scenarios use the same annual transaction assumption that started at $365 million in 2010 and increased to $30 billion in 2014 based on publicly published information.
As shown in Chart 1, the number of Square’s transactions increased every year and reached $30 billion in 2014. However, only a small fraction of this figure ended up with Square as it charges 2.75% of every swipe transaction, and, in average, 71.6% of these revenues are charged by credit card companies as transaction costs. This left Square with almost 30% of its gross revenues and less than 1% of its total transactions as net revenue.
As the competition between PayPal, Amazon, and other electronic payment services increases, Square differentiates itself by offering inventory, invoices, and transaction analytics tools. Merchants could use these tools to enhance their operating knowledge of their business and to improve processes, marketing campaigns, and inventory management. Square understands the potential of the data it integrates and eyes a bigger, more profitable market – the data analytics market. As all transactions that go through Square are tracked and monitored, the company has a large amount of aggregated data that can drive insights about retail sectors, industries, size of businesses, trends, etc. This information can be used by corporations to select store locations, correctly price merchandise, understand market trends, etc. Data analytics is Square’s emerging revenue stream and expected to drive substantial revenues in the future compared with transaction fees net revenues.
Funding and Valuation
Square raised around $600 million in six equity funding rounds, one debt raising round and one tender offer to sell stocks of employees and current stockholders in the secondary market. Square intrigued many investors who usually focus on either tech or finance and notable investors include venture capital funds like Sequoia Capital, Kleiner Perkins Caufield & Byers and Tiger Technology Global Management as well as financial institutions such as Visa and Citi Ventures. As shown in chart 2 below, Square’s valuation spiked from a decent $45 million in 2009 to $6 billion in 2014 valuing Square’s stock at $150 per share.
Square Stock Price Estimation
Square’s latest $6 billion valuation together with estimated annual revenues of $358 million at the best scenario and $238 million in the mean scenario gives Square a price-to-sales ratio (P/S ratio) in the range of 16.7 to 25. This price-to-sales ratio might seem high. However, this does not include any revenues from data analytics, which would contribute substantially to Square’s revenues. Assuming that Square can generate around $50 million of revenues from data analytics (similar to small data analytics startups), its valuation would improve to a P/S ratio range of 14.7 to 20.8, at the best and mean scenario, respectively. The worst scenario, reflecting a P/S of 50, is excluded as the company would not go on with its IPO plans with such a high valuation since it would be impossible to sell to investors.
For a successful Square IPO, the company should split its stocks to offer a more compelling stock price than the current price of $150. A reasonable 3:1 split would not change the company’s valuation and would set the Square stock price at $50 per share. As Square’s valuation is a bit high, the company should offer a discount of 10% on its series F prices post-split, which would set the Square stock price at $45. Therefore, a reasonable price range for Square’s IPO is between $45 and $50 after a 3:1 split. With a price range of $45-$50 and P/S ratio of 14.7 to 20.8, Square would be on par with big data analytics firms such as Splunk (SPLK), New Relic (NEWR) and Tableau (DATA).
While there is no Square IPO date yet, the electronic payment service provider is expected to go public this year, and join other 2015 tech IPOs. Currently, Square business model is based on revenues from transaction fees. However, the company’s future is in monetizing its aggregated data and offering data analytics. Under the current business model, Square books less than 1 cent of every $1 of payment transaction made through its service. Data analytics revenues should be substantially higher than that and slightly improve the company’s valuation to be on par with big data analytics firms. As Square’s preferred stock price surged to above $100, a stock split is required to make its share price more appealing to investors in the IPO. A 3:1 stock split and a conservative discount of 10% will drive Square’s IPO price range to $45-$50 with P/S range of 14.7 to 20.8. Square’s attempt to penetrate the data analytics market makes it an interesting IPO to follow.
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