Square's Most Significant Opportunity Is Still in Mobile Payments.

By Kevin Curran Real Money



Square's (SQ) stunning $29 billion deal for Australia-based fintech company Afterpay (AFTPF) is attractingsignificant attention and aiding shares of the San Francisco-based company in their continued ascent higher after a solid earnings release on Monday.


"Square announced it is acquiring BNPL [Buy Now, Pay Later] leader Afterpay for $29 billion in stock, enhancing Square's positioning across both its Seller and Cash App Ecosystems," Cowen analyst George Mihalos commented in a note to investors. "While not cheap, the deal makes strategic sense to us."


However, as Mihalos notes, the deal is only part of the company's broader ecosystem. As such, it is only ancillary to the segment of Square's business that offers perhaps the greatest opportunity for investors: mobile payments via its Cash App.


Momentum in Mobile Pay


While Square is not a first mover in the mobile payments space, its Cash App has quickly become a major player, now courting more than 40 million users. Along with this rapid growth, the Jack Dorsey-led company has come to challenge earlier entrants like PayPal (PYPL) , Apple (AAPL) Pay, and Google (GOOGL) Pay.


In fact, Square's Cash App nearly doubled its user base over the course of the COVID-19 pandemic's boost to mobile pay. The rapid rise has drawn the app into a neck and neck race with PayPal's Venmo and Apple's Apple Pay for the most popular mobile payments app among U.S. users, per user statistics provided by Business of Apps.


In terms of financials, revenue growth in the second quarter wowed analysts by charting 87% growth in revenue and a 128% rise in gross profit year over year. In terms of growth rate, that outpaces its peers as well. The figures are also encouraging because it does not even account for Bitcoin, which has often distorted Cash App results in recent quarters.


Similarly, Truist analyst Andrew Jeffrey expects the Afterpay acquisition to only add to these positive engagement and financial metrics.


"From a Cash App standpoint, we believe the ability to manage After accounts from Cash App will bolster industry-leading engagement, and it could accelerate direct deposit revenue growth," he told investors in a note on Monday. "We accordingly expect Cash App will maintain meaningfully above-trend long term segment net revenue and gross profit growth."


Still, the growth in the existing market and solid financial results reaped thus far is only a glimpse at where mobile payments stand, not where the industry appears inevitably to be moving.


Far East Movement


Mobile payments in the U.S. and Europe, despite growing rapidly in the course of the COVID-19 pandemic, still have quite some room to run. Perhaps the best roadmap of how the industry will continue to grow is found in China, where mobile payments are more mature than in the collective West.


Per Santander Global research, less than 10% of transactions performed in China are made in physical cash. Further, 80% of the remaining transactions not made in cash are made either through WeChat from Tencent (TCEHY) or Alipay from Alibaba (BABA) .


Compared to this exceptionally high percentage of mobile payments in China that charts into the hundreds of millions in terms of individual users, about 92 million Americans used mobile payment apps in 2020. While this figure is a major jump from 2019 as the pandemic powered on mobile payment platforms, it still represents less than half of smartphone users.


For investors, this could mean an chance to get in early on a trend that is likely to accelerate to the level of China's penetration in the future.


Per market intelligence firm eMarketer, U.S. mobile payment platforms are set to gain about 30 million users over the next five years while courting an ever-larger share of younger, mobile-native consumers. By 2025, over 50% of smartphone users are expected to employ mobile payments, catching on to a trend already established in the Far East.


Card Carrying Competitors


Nonetheless, similarity to the trend seen in China is far from certain. At the very least, the market's consolidation around so few firms is almost assuredly not going to be the case.


"The Payments industry is very competitive with both existing and emerging competition," Cowen's Mihalos noted. "All [payment] companies face the risk of being unable to capture market share or having their business models become commoditized by newer entrants in the market.


In terms of current competitors, there are plenty of major players. This includes tech behemoths like Apple, Google, Samsung (SSNLF) , and Amazon (AMZN) , credit card giants like Visa (V) , MasterCard (MA) , and American Express AXP, as well digital-first leaders like PayPal, Stripe, Zelle, and Square. That is not to mention banks like JPMorgan Chase (JPM) and Goldman Sachs (GS) either partnering with mobile payment leaders or pursuing their own options to maintain market share, though with varied success.


At present, PayPal is the dominant player given its extensive track record, brand recognition, and trust. As such, it is encouraging significant excitement among analysts to much the same degree as Square.


"We view PayPal as one of the more exciting stories in our payment processing coverage universe, checking several key boxes on investors' scorecards," J.P. Morgan analyst Tien-tsin Huang wrote in a recent note, adding particular emphasis to good traction for Venmo and mobile payments.


In terms of entrenched competition in the U.S. specifically, credit card companies and banks might prove particularly hard to dislodge despite secular trends toward mobile pay and tech-focused firms. That is at least in part due to card payments playing a much larger and long-standing role in the U.S. than other regions as well as their interlinkage with the banking system.


"The same economics that make China's system beneficial for merchants but bad for Chinese banks are why the Chinese system is unlikely to catch on in America," Aaron Klein, Policy Director of the Brookings Institution's Center on Regulation and Markets wrote in a recent report. "But it may be more viable in other countries with less-developed banking systems."


Indeed, it may be that banks and entrenched payment industries are inhibiting the already impressive growth of mobile payments. However, digital disruptors should never be counted out in their pursuit to displace legacy industries. At present there may not even be a need for displacement given the size of the untapped opportunity.


That said, some analysts even see mobile payment leaders like Square ultimate supplanting banks themselves before too long.


"We believe Cash App may be en route to becoming the ultimate neo-bank and the money center bank of the future," Mizuho analyst Dan Dolev told investors in a note in July. "This could make buying SQ analogous to buying JP Morgan in 1871."


Whether such a bullish statement is given to hyperbole is a matter of interpretation. The presence of a prescient opportunity in mobile payments is certainly less so.