Block, Inc.

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

Block, Inc. (formerly Square) is a financial technology company that operates two main ecosystems: Square, which provides payment processing and other commerce solutions to small and medium-sized businesses, and Cash App, a mobile app that enables peer-to-peer payments, trading, banking, and more for individuals.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Block operates two distinct but interconnected ecosystems:

  • Square Ecosystem: This segment focuses on providing services to sellers (mostly small and medium-sized businesses) through integrated payment processing, POS software, hardware, and other related services. It offers a complete set of tools to help businesses manage their operations and grow, all while taking a cut on each sale.

    • This business line has an established customer base and provides recurring revenue. The scale of its operation is a competitive advantage, but there is fierce competition in payments processing and other merchant services.

  • Cash App Ecosystem: Cash App caters to individual customers, providing a variety of services beyond basic money transfers, such as the ability to invest in stocks and Bitcoin, to conduct direct deposits, and to utilize a debit card for spending. It’s designed for easy use and accessibility and attracts users through word of mouth and online engagement.

    • This business segment is experiencing rapid growth but also faces the risk of competitors that can replicate the app’s features.

Revenue Distribution

Block generates revenue from several sources:

  • Transaction-based Revenue: This revenue segment includes a percentage of sales processed by sellers on the Square platform. A larger percentage is usually extracted from sales with lower transaction fees, while a lesser percentage is extracted from a high transaction volume. The core business model is a source of stable revenue.

    • Subscription and Services-Based Revenue: This segment includes revenue from subscription to software solutions and other services offered by Square and Cash App. These revenues tend to be more predictable and higher margin compared to transaction-based revenue.
      • This line of business, through the cash app ecosystem, is rapidly increasing.
    • Hardware Revenue: This revenue includes sales of hardware products such as POS systems, terminals, and card readers. As a low-margin, commodity-type business, this line of business does not represent a significant share of overall revenue.
  • Bitcoin Revenue: As of 2021, Bitcoin revenue started to be reported by Block for its Cash App offering. In the cash app, Block sells Bitcoin to its customers, generating revenue at the time of sale. This revenue is dependent on Bitcoin price and market conditions, which makes it volatile.
    • Other Revenue: Revenue earned from all other sources of the company.

The financial technology industry, especially the areas in which Block operates, faces numerous challenges.

  • Intense Competition: The market for both payment processing and consumer financial services is characterized by intense competition. Traditional providers such as banks and fintech companies, new entrants, and established players are all battling for market share.
  • Regulatory Scrutiny: The financial industry, by its nature, is subject to heavy regulatory scrutiny and oversight and that extends to fintech startups. There is increased scrutiny on cryptocurrency and digital currencies, which will impact the performance of Cash App.
  • Rapid Technological Change: Both sides of Block’s business are susceptible to fast changing technology and the entry of competitors offering more streamlined, more user-friendly services. The industry requires firms to innovate frequently to stay competitive and that is a high cost that can be hard to recoup when competitors can easily imitate innovative features.
  • Evolving Consumer Preferences: Consumers expectations are constantly changing. It makes it hard for companies to provide a consistent experience as what users are seeking in fintech evolves quickly.
  • High Inflation and Economic Slowdown

Rising inflation is hurting many businesses and consumers, which leads to less capital and funds to be invested. It also reduces disposable income, leading to less transactions made.

Competitive Landscape

Block faces different types of competitors in both of its ecosystems:

  • Square Ecosystem: This side of the business competes with established payment processors like Fiserv and Global Payments, legacy POS companies like Oracle, and also with the new wave of fintech companies that include Clover. *The business faces price competition and intense effort to capture larger businesses with customized enterprise solutions.

  • Cash App Ecosystem: This side competes with established financial institutions, digital payment giants such as PayPal, and also with a rapidly growing number of neobanks, offering different financial products including banking, investing, lending, and saving.

    • The threat of imitation of their model and also the intense competition between well-established and new fintech players is a concern.

What Makes Block Different

Block stands out by offering:

  • Integrated Ecosystem: Both its Square and Cash App ecosystems are deeply integrated, which lets merchants and individuals enjoy a seamless flow of value and information.
  • Emphasis on Small and Medium-Sized Businesses: Square is known for catering to smaller businesses, which traditionally had more difficulty in accessing affordable financial solutions.
  • Focus on Innovation: Block is continuously trying to improve its payment processing and other services with new solutions. The introduction of Cash App is an example of the innovation.
  • Community Approach: Block actively promotes community engagement with both sellers and individuals, resulting in high customer retention rates.

Financials - In-Depth Analysis

  • Revenue: Block’s revenues have been increasing steadily, mostly driven by growth in both ecosystems. A major boost to revenue was recorded in Q3 2022 when Block acquired Afterpay. Revenue increased significantly from $4.4 billion in 2021 to $17.6 billion in 2022. Revenue for the latest quarter, Q3 2023, was $5.62 billion, up 24% year over year.

  • Transaction-based revenue is consistently strong. A concern is that while gross profit has been increasing, the rate of growth of profits is decreasing as competition rises in the payments industry.
  • Bitcoin revenue is extremely volatile because it depends on market sentiment and price fluctuations.

  • Subscription revenue has been performing well, and it is rapidly increasing due to the expansion of Cash App’s features.

  • Gross Profit: Block’s gross profit has been increasing due to the increase in volume. Gross profit has steadily grown from $2.12 billion in 2021 to $6.64 billion in 2022. In Q3 of 2023, it posted $1.84 billion in gross profit, a 23% year-over-year increase. *The gross profit trend is a key metric for performance, but the growth has slowed.

  • Net Income: The profitability picture has been extremely difficult. The company has lost billions of dollars in net income over the past three years. In 2021, it posted a loss of $207.6 million, followed by a staggering loss of $1.585 billion in 2022. Loss continued in Q1 2023, followed by profit in Q2 and another loss in Q3. While loss in the last quarter was smaller, $35.5 million, the trend is still unstable. Block’s management will have to deliver positive income over the long term for a more stable investment.

    • Recent losses are partially due to the large impairment charges. However, as the market matures, the lack of solid net income raises concern.

  • Return on Invested Capital (ROIC): Block’s return on invested capital is also struggling. In 2021, the return was 1.9%. This has slightly increased to 6.7% in 2022, but it is still very low compared to well-established fintech companies.

    • As a technology and financial services company, it is paramount for Block to increase its ROIC.

  • Operating Expenses: There have been significant increases in both operating expenses and selling and marketing expenses as the company is trying to expand its presence and product lines. A closer look reveals that both lines have decreased as percentage of revenue but have still increased in absolute value.

    • Though they are high, it should be expected that these expenses should be high as the company is still trying to get a foothold in the industry.

  • Liquidity and Capital Resources: Block’s liquidity remains strong with $7.9 billion in unrestricted cash, cash equivalents, and marketable securities at the end of Q3 2023. However, total debt is also relatively high at 5.1 billion dollars.

    • It is concerning that the company’s debt-to-asset ratio has been increasing over the recent few years.

Moat Rating: 3 / 5

Block exhibits a “narrow moat,” meaning it has some competitive advantages that are valuable but may not last indefinitely due to competition and fast technological change. Here’s the breakdown:

  • Network Effect (Cash App): The Cash App benefits from a moderate network effect, as more users attract more participants and increase engagement. However, the network effect is not as strong as those in well established social media companies.
  • Switching Costs (Square Ecosystem): Square creates switching costs for its merchants due to the time that is needed for data transfer and familiarization. However, if a company gets an opportunity to move to more feature-rich and lower-priced competitor, a large number of customers can switch as well. These costs are high for many retailers.
  • Scale and Brand Awareness: Block has built some scale in payment processing, while its brand is becoming more known. However, neither scale nor the brand have reached the heights of many large competitors.
  • Intangible Assets: The company owns some software and patents, which do provide some protection. However, these patents are not difficult to replicate for competitors or may be made ineffective by time.

Risks to the Moat and Business Resilience

There are several legitimate risks that could damage Block’s moat and challenge its business resilience:

  • Increased Competition: The financial technology industry is becoming more crowded than ever. New players are trying to compete with existing businesses. Block may find it tough to maintain its moat against larger competitors or new upstarts.
  • Regulatory Risks: Stricter regulations surrounding fintech, cryptocurrencies, and data privacy could negatively affect Block’s operations and profitability.
  • Cybersecurity Risks: Block handles massive amounts of sensitive financial data of both its merchant and individuals. There’s a constant risk of data breach or cyberattack that may erode its reputation and expose the company to financial risks.
  • Economic Slowdowns: Economic downturns and recessions can result in lower consumer spending, reduced business activities, or lower transactions, all of which can directly affect Block’s revenue.
  • Market Saturation: Markets of all the business lines may become saturated by other companies over time as most of them do not have network economics.
  • Adoption of New Technology: Failure to adapt to new technological changes or adoption of new technology by its competitors can be a major headwind to future growth.

Despite these challenges, Block also has several strengths that may provide resilience. Diversification in both individuals and business financial services, loyal customers, and its innovative products. However, more needs to be done to create strong profitability and sustainable cash flow.

Understandability Rating: 3 / 5

Understanding the core business of Block isn’t too difficult, but to fully grasp all of its complexities, a user will have to dig deeper. Here’s the justification for giving it the 3/5 ranking:

  • Easy to Understand Business Model: Both the Square ecosystem and the Cash App ecosystem have clear purpose and simple value propositions. But the various offerings and the interaction between both ecosystems makes the business difficult to completely understand.
  • Complex Financial Picture: Although there is a ton of data available and publicly accessible, analyzing all of Block’s financial data and determining meaningful and relevant patterns is difficult. This is made worse by the impact of various non-core factors.
  • Dependence on Fintech: Block operates in financial industry, which is difficult for a novice investor. For those familiar with financial systems, the industry can feel like a complex and rapidly changing system to navigate, especially when new technological updates may bring new challenges.

Balance Sheet Health: 4/5

While Block has a strong cash reserve, high debt, volatile revenue and negative net income brings the business down to 4/5:

  • Strong Liquidity: Block has a large liquidity base, allowing it to quickly take advantage of strategic opportunities.
  • The firm has more than $7 billion in cash, cash equivalents, and other short-term investments.
  • High Debt: The business carries a high amount of debt which may increase risk as the interest rates continue to grow.
    • While manageable, the current debt is relatively high.

  • Low Profitability and Negative Earnings: As discussed above, the company is currently making a profit in some quarters but it still is experiencing losses which is concerning from the view of long term performance.

    • While the balance sheet appears strong, the poor profitability brings this rating to a 4.

Recent Concerns, Controversies, and Management’s View

Block has faced a number of recent concerns that investors have raised.

  • Slowing Growth: The company’s growth rate has started to slow down across both its ecosystems. This has led many investors to reconsider the investment prospects for Block.
    • Management has acknowledged the slowdown, but remains optimistic about future growth through innovation and new products.
  • Profitability Concerns: As mentioned earlier, the net profitability is unstable and the company has posted multiple quarters of loss. This remains a major concern for investors, and a primary goal of management should be improving the bottom line.
  • Management has expressed its intent to cut down on unnecessary costs and to focus on value-creating projects.
  • Bitcoin Volatility: The volatility and unpredictability of the Bitcoin market have resulted in large swings in the company’s earnings.
    • Management has tried to alleviate this risk, but further action is needed to reduce dependence on the crypto market.
  • Share Price Volatility: The company’s stock has shown extreme volatility, resulting in huge gains and huge losses to investors. This has further intensified concerns about the company’s long-term prospects.
    • Management has tried to convey information and transparency about their operations, but more should be done to assuage concerns regarding the stock volatility.

In Block’s latest earnings call, the management stated that they remain committed to improving the performance of both the Square and Cash App ecosystem while focusing on long-term value creation. They also emphasized the reduction of unnecessary costs and focus on growth within the core parts of the business.