To The Moon

Block, formerly known as Square, is a company founded by Twitter co-founder Jack Dorsey. Initially, it provided payment and mobile banking services to merchants and consumers. The mobile internet accelerated its growth, making Cash App one of the most widely used Fintech applications. Company has also successfully expanded its business from payments to peer-to-peer lending, online credit cards, digital currencies, investment trading and other businesses.

In Q4 2022, Cash App's MAU rose to over 50 million.

March 23rd, Hindenburg Research released a short report titled "Block: How Inflated User Metrics and “Frictionless” Fraud Facilitation Enabled Insiders To Cash Out Over $1 Billion," targeting the company for inflating user data, facilitating criminal activity, and insider cash-outs.

In short, the growth of the company's business is not supported by disruptive innovation but rather by fraud against consumers and governments, evason of regulation, disguising predatory loans and fees as revolutionary technology, and misleading investors with false metrics.

Specifically

1. Seriously exaggerated the number of real users and underestimated its customer acquisition costs. Former employees estimated that 40%-75% of the accounts they reviewed were fake, involved fraud, or were additional accounts linked to a single individual.

2. Admission of a traditionally very "unbanked" population: criminals. The company's disregard for compliance has allowed bad actors to mass create accounts to commit identity fraud and engage in other scams, and then quickly withdraw stolen funds. Even if these fraudulent accounts were discovered, Block was blacklisted without being banned, and a former customer service representative shared the evidence.

3. The "intermediary fee" payment is made through a small bank, thereby bypassing the limit of the card issuer's assets of less than US$10 billion in the "Dodd-Frank Act", thereby improving profitability in the case.

4. The acquisition of Afterpay, which avoids Australia's responsible lending rules, provides users with a type of credit without income verification or credit checks, and the buy now pay later (BNPL) service company Afterpay generates higher Losses and more defaults.

5. Insider Selling. Co-founders Jack Dorsey and James McKelvey have collectively sold more than $1 billion in stock during the pandemic.

At the same time, the bulls did not take this short report seriously.

"Innovative" investors with high risk appetite, including Ark Fund$ARK Innovation ETF(ARKK)$ , still believe that the company has strong growth potential. Cathy Wood has increased her holdings of Block shares for two consecutive days. The three ETFs under Ark bought more than 338,000 shares and 167,000 shares of Block shares on March 24 and 25, respectively, with a total value of about 50 million US dollars. Note, At the same time she sold $Tesla Motors(TSLA)$ shares.

Investment Highlights

We mainly look at two aspects: 1.business 2. valuation.

In terms of business

Hinderberg was tough to successfully snipe the richest man in India. Almost every shot of Block is accurate-inflating users, condoning crimes, and bypassing regulations. These are quite serious problems in the United States. As long as it is confirmed, not to mention that existing business may be hit, more lawsuits will flood Block to overwhelm himself.

Or go to Congress to testify?

As a technology company, Block has taken advantage of it in the development process. The reason why it can cooperate with banks and keep bypassing banking supervision is because the supervision may not regard it as a member of the "banking system". So banking and the wider financial industry tends to be very heavily regulated.

For example, all financial service providers are obliged to do a good job of "KYC", that is, "know your customer", in order to protect key customer data and prevent illegal activities such as fraud and money laundering. However, when these Internet companies operate in practice, they may often take advantage of loopholes. Payment applications such as Block’s Cash App and PayPal’s Venmo avoid many KYC requirements by adopting a layered approach. Currently, PayPal is under SEC scrutiny, and Block is likely to be next.

At the same time, Block will spend more to re-examine internal processes and standardize business, although this must be done, because rampant fraud on any financial platform will only hurt honest users and financial practitioners, and in the long run is unfavorable.

And Block's own response to the short-selling report also lacks specific refutation points, especially when it comes to issues related to criminal activities, which is almost irrefutable, which is very unfavorable.

In terms of valuation, besides Cash App, are there any uncertainties in other businesses?

The growth potential is why Block can continue to enjoy a valuation multiple that is much higher than its peers. Currently, Block's adjusted EV/EBITDA is 60 times, and its forward P/E ratio in 2023 is 40 times. At the same time, PayPal's EV/EBITDA multiple is 16.6 times, and its adjusted 2023 P/E ratio is 15 times.

The difference is that the growth rate of Block is slightly higher.

But can this growth rate be maintained? Because both Cash and Venmo have passed the high growth period, the growth rate in 2022 has almost evened out.

Block currently has two big risks, Cryptos and the Australian subsiary Afterpay.

Although Bitcoin’s good performance in March in banks liquidity crisis, Cryptos is still facing more severe supervision.

Afterpay is a fintech company with core business "buy now, pay later" solutions.

When consumers buy products, Afterpay pays the seller and asks consumers to pay 25% of the payment.Afterpay makes money by charging merchants fees and charging customers late fees. Its merchant network has to pay a percentage fee on every sale made through the Afterpay network. Typically, this fee is 4% to 6% of the transaction value, plus a flat rate of $0.30.

Companies like this business were in hard mode in the interest rate hike cycle (and the recession cycle that may follow), the probability of default increases and Block’s financial report will have more Estimate Credit Losses.

From these points, regardless of whether the issue of Cash App being exposed will continue to simmer, several business lines of Block are now facing strong uncertainties. Even if the illegal activities are reduced by improving risk control, the company is very Some profits are likely to be affected in the long run, ie, the long-term profit margin declines.

This is also matters to investors like Cathy, who like to use a 10-year vision.

It’s just that the secondary market has always been only a reflection of investor sentiment. Most investors who interested in Block have a high risk appetite. Therefore, the volatility of Block in the secondary market is relatively large. At the same time, once the short investment When investors surface, short-term stock price volatility are not just as simple as anchoring valuations.