Chit Chat Stocks - Block (Ticker: SQ) Not So Deep Dive

Episode Date: February 21, 2023

Block, formerly known as Square, is a financial services and digital payments company that provides mobile payment solutions and other financial services to small businesses and individuals. The company was founded in 2009 and is headquartered in San Francisco, California. At the end of the month, we will publish an Arch Capital episode that will cover the company: Nelnet. Listen closely as Brett and Ryan go through the history, financials, and future prospects of Block. Enjoy the show! ****************************** This episode is sponsored by Stratosphere.io, a web-based terminal for financial data, KPIs, and more. Try it out for FREE or use code “CCM” for 15% off any paid plan. Sign up here: https://www.stratosphere.io/ ****************************** Subscribe to our Substack to receive free show notes and charts that go along with every episode: https://chitchatmoney.substack.com/ Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Contact us: [e-mail] Timestamps Company Background | (3:06) Industry | (17:40) Management & Ownership | (22:30) Earnings | (27:09) Balance Sheet | (30:28) Valuation | (33:24) Our Analysis | (34:39) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome into Chit Chat Money. My name is Brett Schaefer, and I'm joined by my co-host, Ryan Henderson, as always. And today is our Tuesday, quote unquote, not so deep dive episode,

where we analyze one stock by covering its business model, ownership, financials, future growth opportunities with some of our opinions mixed in. After listening to this episode, we hope you get a better perspective on the company and either get inspired to research it further or potentially not research it further. These are not recommendations and are just, I don't know. It's hard to describe what these shows are, but we want to make it clear as always, that they're not- Hopefully, it's hopefully a way to expedite your research process,

a way to speed up and learn about a business. And if anything, just help you out. All right, today we are covering Block. But before today's episode, I want to talk about Stratosphere. Today's episode is presented by Stratosphere, our investing home screen for fundamental research. What we've been saying is you want to ditch Yahoo Finance

and start using Stratosphere's dashboard tools to let you easily track investments. We use it every day. And we use it for researching stocks with our nifty newsfeed, SEC file aggregation, and a fundamental charting tool to compare companies. It's perfect. I mean, Ryan, any, I don't know,

what's a feature that you've been loving on Stratosphere? Well, I mean, this is basic because it's kind of the crux of the value proposition that they provide. But I like the segments and the KPIs that are like company specific, because it makes me realize this had to be so frustrating to build. They've done it, but it had to be so frustrating to build because companies are not always regularly reporting things. And so there's times when you probably said,

oh, that's a great KPI, I can use that. And then all of a sudden they stop reporting. And so it's got to be so frustrating. but they've done a really good job aggregating all that stuff. So it's just so much easier for us. All the frustrating work that you do, that we do as investors, they're trying to take care of that yourself. Save you time. And the best part is it's free. So you can do plenty more at stratosphere.io. Try it for free. That is stratosphere.io and use promo code CCM for 15% off any paid plan. We will be using them throughout this episode okay ryan um why don't you try to describe what block is

formerly known as square i know jack dorsey has a nice little saying that he likes to do that you're going to share with us yeah and we probably have a bunch of regular listeners that are hearing this and might get like frustrated at some of the basics that we talked about here but remember there are potentially new listeners so people that maybe don't know block as a business and i'll try to go through some of the basics but also maybe provide some deeper context on the products and how they've evolved over the years but jack dorsey describes block as an ecosystem of ecosystems um yeah that means nothing pretty much um other people would maybe describe it as a company that has multiple products and so i'll go through each of those and start with

Square itself. So this is really what the company was founded on. It's their seller ecosystem or sort of their commerce ecosystem. It's designed mostly for merchants, small to medium-sized businesses. They're moving more towards sort of the medium size instead of just purely the small size. But this is a mix of both hardware, software, services, and pretty much it's very self-serve so um you think about some of the bigger potentially um payments processing services and they are maybe more customized for specific end users in this case it's very out of the box where a small business takes it or orders it whether that's the hardware and software you can easily just add on your specific service software services that you need you can automatically

accept payments via cards or Apple Pay or digital payments as well now, and I'll talk about that in a second. But I think Scuttle Blurb, which is a blog we personally subscribe to, described it well. It's a general purpose stack, a general purpose merchant stack, basically, that provides everything a merchant might need. And it's really well suited for retailers that have sort of one to 20 locations. That's kind of the sweet spot. Toast is another competitor that maybe applies to a little larger customers, so kind of the 20 to 100 locations range, but Square really serves that sort of smaller to medium-sized niche. Like I said, though, they obviously have the hardware that provides the payments processing functionality, but they also have a bunch of

additional subscriptions and, I guess, software services that customers can purchase on a going basis. Some of them are variable costs. So some of them are like, you know, $1.50 every time you use it, point blank percent of each transaction, that kind of thing. Whereas some are more on a monthly payment. Each one's very different. You can go and just look it up online and you can find sort of the payments or the different pricing. But these include things like team management payroll email marketing tools loyalty programs appointments is a big one um and so really a whole suite of different kinds of software services and they've recently been seeing a lot of success with the verticals solution so this includes pretty much square

for restaurants square for retail and appointments basically these are a number of software services that your typical retailer or your typical restaurant might need. And they can subscribe to it for a monthly price, probably plus a couple of variable rates. But it's seen a lot of success. So for reference, in the last quarter, those three verticals grew at 45% gross profit, as opposed to overall square,

which was growing at a much lower gross profit rate. So this is kind of helping, I think, drive growth for the ecosystem as a whole, but I hope that gives sort of a good perspective on what Square's seller side looks like. The second one that I'd probably call this the most important segment of the business or ecosystem is the Cash App. And so this is Block's all-in-one finance app. It started with its core peer-to-peer transfer function. So similar to Venmo, where you could just send money to your friend. however they've layered on a bunch of additional products on top that really make this sort of a

true digital banking product so today when a user sets up an account they're immediately given a routing and account number users can then receive direct deposits from an employer they can transfer money from another bank account in they can deposit paper money through physical locations They can receive money from friends. And then once the money's actually in, there's a bunch of functions that they've added on as well. So you can hold it and there's like different savings accounts you can put it in. So as far as I can tell, they don't earn interest in those savings accounts, but it's basically meant to be sort of a separate account where you potentially, and you like pick an emoji apparently, whereas like what you're saving for. I think they, we should have confirmed this.

i think they earn interest on some stuff but again they are not a regulated bank on the consumer side yet so again there are they don't they can't be as robust with their lending stuff right now okay yeah i didn't see anything but um i i heard him say i i heard him say one thing on the conference call maybe they were talking about the loans they give out but well i don't know either way they're not they don't act like a bank yet no i mean they do everything beyond basically interest in savings accounts from what i can tell and um credit cards but they are kind of moving into credit cards potentially in this i'll explain what that is in a second but when the cash is in a user's account they can also invest it in stocks um there's a number of

different you know sort of your typical range of equities but as well you also have etfs um there's some bond ETFs. So maybe people don't, maybe that's a way to sort of earn interest in sort of a short duration bond ETF, as opposed to just them giving you one, giving you interest on your account. And then you can also buy crypto, which they've really tried to emphasize. And then they're rolling out this new borrowing function, which is similar to a credit card. They're trialing it with users right now. But basically, I think you can borrow up to $200 from cash app that you obviously probably pay them back very similar to your typical credit card. They're trying to basically be a bank without being a bank.

Yeah, that's probably a good way to describe it. And then there's also and here's the part where it kind of ties the two ecosystems together. So we've talked about how you can ingest or take in cash from a number of different places. You can do a lot with the cash while it's in there, but then you can also pay it or spend it or send it in a number of ways. And so there's the Cash App Pay, which is sort of your basic... It's a way to pay at square merchants. So it's either physical or online. If there's a square merchant, they accept Cash App Pay. You can pay directly out of your account, or you can scan a QR code and pay directly from the money that's in your cash app. There's the cash app card, which is a physical and digital card that

they send to you. You can add that to your Apple wallet. So like when you pay with Apple Pay, you can pay with your cash card on there. Then they also have boosts. So these are basically discounts where if you use your cash card, you get say $10 back at a local grocery store or something like that a lot of chains kind of offer discounts in there um and so it's sort of a way to incentivize spending um i guess other way i guess on the cash app pay thing that they're starting to roll that out to some other third-party merchants so not just square merchants but that's kind of the way they're trying to tie the two ecosystems together is through the the payments function for your square sellers and then square sellers can easily direct deposit

into their employees' cash-up accounts. So hopefully that... And then there's a number of different ways they make money on that. So when it's transferred to and from a bank, when they charge, there's just these tiny little microscopic fees that have really sort of

added up to a lot of gross profit. I think it was more than 2.6... I want to say $2.6 billion in gross profit over the last 12 months for Cash App specifically. That is correct. And I'll have a chart of the Cash App gross profit in the newsletter, which people should subscribe to. And then the other three segments or ecosystems here

are Afterpay is one. So Block acquired Afterpay. Most people probably know this. Ultimately, the deal ended up being for $14 billion. I believe it was initially quoted at, and correct me if I'm wrong here, I think it was $29 billion. It was an all-stock deal, so both stock prices kind of collapsed and the deal wasn't worth as much.

But at the time that it was announced, it was like $29 billion, 42 times sales, I think, was the deal. But it came in. And this is their BNPL provider. And for those that don't know, that's just buy now, pay later. Dare I say, very commoditized. But Afterpay was sort of unique in that there was a lot more of a discovery element to their platform as opposed to some of the other ones. So when it's like a big time connection to the embrace like apparel and fashion shopping and try to get that kind of feedback loop going within their app. So we'll talk about whether it's a commodity later, maybe.

And it was bigger. It was it was found in Australia. i think they had a bigger presence there um but this it's meant it was trying to be more of a digital mall instead of just a checkout option um and so you could go on to afterpay.com or whatever it was called and you could look up all the different merchants that accepted after pay and you could kind of uh peruse a bunch of different options from that one dashboard um so they acquired that they've been slow to kind of integrate that in the third quarter they did for their first i guess uh attempt at integrating some discovery tools into the cash app where you can use uh sort of after pays where they're using sort of after pays platform um i'm it's not a big

part of the cash app right now the only other thing they've done is uh given this functionality to all the square merchants so it really doesn't seem to me like a like a big part of the business yet um and then growth has slowed a lot uh for after pay relative to when they first bought it but the the fourth one here is title um this is their music streaming platform block bottom for 297 million dollars in cash in 2021 this functions really similar to other music streaming platforms so they've got three tiers there's a free ad supported tier there's a hi-fi tier which is 12 a month uh unlimited songs uh you can listen to songs offline it's very similar to spotify and then there's a title hi-fi plus which is apparently has better sound quality and they say

as much as 10 of your subscription is directed to the artists you listen to most i know that was a hundred percent but you know we don't need to we don't need to we got to finish you know we got a timeline here ryan so i don't know if we can go into that but okay well we'll discuss title and highlights and lowlights it's very small relative to um the other music streaming offerings and then there's a bunch of bitcoin related initiatives i watched their investor day presentation on their crypto ecosystem and came away kind of lost um i think they're probably discreet on purpose here but i i they actually like their spiral and tbd brands really don't have like they have a very generic purpose which is uh work on whatever they think is best for

Bitcoin. Apparently, that includes software development kits for wallet developers, decentralized mining systems, and a bunch of other stuff I didn't understand. So I'm going to limit it to that. But as for the history, most people know the story. So I'll be real quick. Square was founded in 2009 by Jack Dorsey and Jim McKelvey. Jack had just been ousted by the Twitter board. Apparently, his friend was trying to sell art and didn't have a way to accept card payments. And so they came up with this little dongle that you could plug into your phone, accept card payments easily. It was a simple card reader that was pretty successful. Four years later, they launched a product called Square Cash. This eventually

evolved into the Cash app. It just allowed individuals and businesses to set up an account called the Cash Tag and quickly send and receive payments. They went public in 2015, acquired weebly in 2018 acquired title in 2021 acquired after pay in 2022 since the ipo the share count has nearly doubled so there's some dilution here we're going to talk about that a bit but it's also um just kind of think in context of if you're looking at gross profit growth over the time kind of just cut it in half on a to look at on a per share basis This is maybe the way I would do it. But yeah, that's pretty much all the history.

There's nothing too relevant as far as founding story, aside from the fact that they retain a lot of the business today. Yep, they're still around. I'll get to that management and ownership. It was pretty innovative, that first one. That first product really started a whole new industry. So it's quite interesting. But yeah, industry and competition, that's our next section here.

Pretty simple. I mean, for Cash App and Square, they're both large. At the 2022 Investor Day, management estimated that the Cash App had a $70 billion gross profit total addressable market, and that Square had a $120 billion gross profit total addressable market, or TAM, as we might reference to it later. And for reference, over the last 12 months, their total gross profit as a company was $5.5 billion. So they're pretty big in each of these markets, but they're not the dominant player and they're quite large. So most of these markets are fragmented with lots of players. There's not like an oligopoly out there. It's not like the payments networks. This is the layer below that.

And I think they outlined that as an international market opportunity. So I'd really be watching that international gross profit growth because it's a small part of the business right now, but growing extremely quickly. And I think that's where a lot of their growth is going to be coming over time, especially if they can launch Cash App outside of the United States, because it's been difficult to launch consumer finance apps internationally. They usually kind of stick in their home country. But again, we might discuss that later. If we look at competitors, the competitors is Square, which are, again, if anyone that is confused here, Square is the subsidiary now of Block that just does the merchant payments and the merchant services.

The competitors here, I'd say the number one would probably actually be Shopify, because Shopify is expanding it to point of sale. Shopify really tries to be the software and payments provider for a lot of small businesses. And their payment volume is the lost payment volume that could have been at Square. I also think Clover is a big competitor, Toast, Wix, smaller. Olo is different, but sort of a competitor. You might have people that use Square also use Olo, but I think that will become a competitor over time, although they don't really sell hardware. Essentially, any company trying to help SMBs or maybe even larger businesses facilitate payments and manage the back office busy work is a competitor to Square. So there's

a lot of them. Competitors to Cash App, there are also quite a few, but the two most important would be Venmo slash PayPal. Venmo and PayPal are owned by the same company. Well, PayPal owns Venmo. And Zelle. Zelle is the one that a lot of people will know. It's the one that connects the big banks, the one they put out together. Those are the two largest in the United States. However, even though Cash App is kind of... They came in late. You might have said Venmo has an early start. Zelle has all the established accounts at all the big banks. Cash App is doing quite well. They're now the number one most downloaded app in the United States in the finance category. If you look at the free downloads that I just screenshotted today from Sensor Tower, Cash App's number one, PayPal's number two, Venmo's number four, Zelle is number five.

But right now, number three is TurboTax. So I think outside of tax season, we're looking at those as kind of the one, two, three, four. Competitors to Afterpay, there's a lot of them as well. Affirm, Klarna, PayPal, plus many more. apple is also rumored to be launching a buy now pay lighter product for uh apple pay which is huge i guess i should well apple play is not really competitor to cash app because a lot of people can put their cash card onto apple pay if you go right so it's like sort of competitor so or not but in front of me yeah because you don't want you some people you kind of want people to start

i guess the most you know monetizable user for the cash app are the ones that stick within the app the whole time and people are sticking within Apple Pay that might hurt them a bit. But again, yeah, frenemy. The question I had here that you tried to address earlier is, is buy now, pay later just a commodity service that anyone can launch? I think, I mean, it's pretty clear that Square or Block, whoever you want, Block really, should have just started this themselves because it's not worth the synergies in Australia and the synergies of adding, say, a few 10 million Cash App users?

Yeah, no, I think it's very clear they overpaid for this. And they've even tried, I think, to be somewhat quiet about what's happened to Afterpay. But I remember saying, I remember seeing that gross profit at Afterpay was growing like 75% year over year prior to the acquisition. And I think now it's at about 6% year over year. So obviously a deceleration that doesn't warrant the premium they paid, but I think PayPal showed that this can be a commodity and it can be developed in-house. Yeah, that's a good point. That's a great point. All right. Management and ownership blocked, I'll say first, is a bit of an enigma to me. There are some things I really, really like.

And on the other hand, there are some things I really dislike. for one. All right, let's just go through the notes. The founder chairperson of the board and current CEO is Jack Dorsey. As Ryan mentioned, Dorsey started this company from scratch and it really has turned it into the behemoth they are today. If we look at something interesting I saw on the proxy filing, there was a proposal to change the dual class voting power. They have class A and class B shares to one share class and one vote apiece. The reasoning for this, according to the shareholders that wrote this proposal, is they dislike Square changing its name to Block and embracing all this crypto stuff. They want more. I think they were requesting it

from the board of directors and just from having the ability from the shareholders to have oversight on Dorsey as he kind of goes off onto his wild adventures in crypto. If you look at Dorsey and his co-founder McKelvey, they have over 50% voting power as of the latest proxy due to their dual class shares. So yeah, I think we'll probably talk about that either in highlights or lowlights, but I think that's important for people to note. Executive compensation at Block is very simple. They pay base salaries and give out a lot of stock options to executives. I didn't see the base salaries were not too large at all. Dorsey gets a $2.75 salary, which isn't a typo. That's kind of the rate on a payment that people get. So that's why they do that. He basically is getting

zero money and he gets no stock awards or other personal benefits, which I liked a lot. Remember, we talked about Zuckerberg getting $0, quote unquote, compensation, then getting $30 million of security paid for by the company. Dorsey, and I think maybe because he doesn't like Zuck very much, but I doubt it's that. I think they just want to show that they're trying to be rational for shareholders is they do not do any personal benefits to executives. They make everyone pay that personal stuff out of pocket. You don't see that very often, which I thought was great. However, or go ahead. Well, when you're a part-time CEO, you can offload some of the costs to the company, but he's no longer a part-time CEO. So this next proxy, we'll see

if anything changes. That's true. That's true. I guess check that for sure. Either way though, they talk about executive compensation being simple, which I like, but for some reason, and this is another on the flip side kind of thing, the board of directors still think it's reasonable to hire a compensation consultant, which is doing, I don't know what they're doing if there's just the simple options plus base salary, but who knows. Total executive compensation 2021 was $38 million, which is really not bad considering how much gross profit they generate. On the other side, there were quite a few related party transactions on the proxy. All seemed kind of fine to me, but it always drives me the wrong way. I mean, for example, it looks like they

signed a software deal with the CFO's husband when there were probably quite a few other vendors that they could have chosen. So I just don't like that. But again, when I saw the related party transactions, all of them seem fine. It wasn't a reason to sell or anything, but- They may have got a discount. Who knows? Maybe it's fine. I mean, one of them was like the Shake Shack CEO is on the board and they use Shake Shack in their boost initiatives, which is not a big deal at all. But again, just something to track uh if we look at man you know ownership nothing crazy you know dorsey owns nine percent mckelvey still owns two percent and then you got the classics vanguard blackrock

morgan stanley all right earnings ryan what do you got for us yeah i think the important part to understand about the ownership is that between jack dorsey and james mckelvey they have 54 of the voting power so they control the company um so when we talk about that uh proposal to make all shares equal in voting power that's probably why there's a bit of a reluctance and they're not gonna he's not gonna vote that um yeah and even even if it goes down over you know we're gonna talk about dilution even though if dilution goes you know makes their thing you know vote and go to say 40 voting power it's still super it's gonna it would be super hard to get that many votes together you really need like you know you're not all shareholders are going to participate so it's

not just like, oh, they're going to go below 50%. Now we're fine. No, no, no. They got to go way, way below 50%. There's only so many funds that could take a massive activist stake at today's valuation, even if Jack Dorsey and the other founder had 40%. So anyway, let's talk earnings. This is really a business where you want to focus on the gross profit because recently, I guess two years ago, there was this accounting change where they had to record Bitcoin transactions as revenue. Basically, they were recording every... I want to make sure I get this right. Ultimately, their spread on the Bitcoin transaction was very, very small. That's what the revenue should have been, and they were reporting it that way. However,

uh i guess gap or whoever the regulating body is came in and said uh we'd like you to do it this way and so since that point in time um it's just best to focus on gross profit so they do about five and a half billion dollars in gross profit that's um 33 gross margin but really just kind of think of gross profit as the top line half of that basically is the square ecosystem stumped. The other half is the cash app. And then 1% roughly is Bitcoin trading. Over the last 12 months, they generated about $300 million in free cash flow. So not a lot of the gross profit dollars really trickled through to free cash flow. And they give out a lot of stock-based compensation and an increasing amount of stock-based compensation as well, I should say.

So it's, it's kind of, um, they're not, they're not profitable. I would say the breakeven profitability was, is that a good way to describe it? Yeah, that's fair. Yeah. Yeah. Right around breakeven. All right. Let's talk a most recent quarter, um, gross profit in aggregate grew 38% year over year. That was actually benefit, uh, that was boosted by the afterpay acquisition. If you exclude that square ecosystem, gross profit was growing at 17% and cash apps,

gross profit was growing by 37%. Cash App is still sort of the, I guess, the growth engine here. Although Square was growing at a healthy rate as well. Negative free cash flow during the quarter. Just in terms of the sort of two drivers there, Cash App continues to grow really quickly. They've got just under 50 million monthly transacting users growing 20% year over year. Then the gross profit per transacting user continues to grow as well. So Square ecosystem is doing well. Like I mentioned, they are having success selling the vertical solutions. So the Square for restaurants, Square for retails, Square for retailer, whatever, and appointments.

And then the GPV mix, which is the payment volume for the business, it continues to skew towards higher or larger companies. And so the percentage of GPV that came from businesses with more than $500,000 in annualized volume was about 40%. That was much lower last year. So they're kind of moving towards enterprise or larger businesses, whether that's intentional, like through their direct sales staff, or that's also might just be a byproduct of that segment growing quicker. Either way, I think that's a positive just because the retention on that is probably higher. Last thing I'll mention, they record $330 million in adjusted EBITDA. I'm going to talk about that in a second, but I would take that with a grain of salt. That's not close to free cash flow at all.

As for the balance sheet, $5.5 billion basically in cash and short-term investments. They also have $800 million in long-term investments, but they're all debt security. So I would probably just lump that in if I'm trying to calculate the enterprise value. They also have to hold a certain amount in customer funds. So they've got $3 billion on the balance sheet in customer funds. and they hold a little over $500 million in Bitcoin. I think part of that is just to provide some liquidity for customer trading,

but they're also taking on the risk by holding it on their balance sheet. So it's, or the opportunity, if you want to call it that, the upside opportunity there. If you're- Hey, last two months, last two months has been upside.

True. But no, I agree. It's a big risk. Liabilities, the big thing here is that they've got four, basically got a decent chunk of real debt, but they also have around $5 billion in customers payable. So keep in mind, I said, they hold $3 billion in customer funds and have a lot more in customers payable. So they are using sort of that working capital advantage to invest in

short-term securities and earn interest on it, which is a positive here. But when we look at the debt. Some of it is senior notes. So $2 billion out of the roughly 4.6 is senior notes, which have interest rates of 2.75%, 3.5%. So fairly low rate. However, the rest of it is convertibles. And a lot of these look like they probably won't hit, would be my prediction, unless shares do really well. So they have some coming due this year, which are in the money. The strike price is $78, I think right now blocks like, what is it? $80 or something like that. Yeah, $80.50. So those can be converted to stock, but the rest of these are due in 2025, 2026, and 2027. And they have share or strike prices of $121 a share and basically $300 a share on the other

ones. So either you're getting some dilution in the coming years, or you're getting more likely debt repayments. If you're getting dilution, you've done well as a shareholder. So there's probably not that much to be frustrated about, but I think more likely you got debt that has to be repaid. Just to consolidate it, they basically have $300 million in net debt. But so the enterprise value is really close to the market cap here. I think they have more than enough cash and earnings before basically EBITDA to pay off their debt. So I wouldn't be too concerned. Yep. And you're not including leases there.

I think the enterprise value I use with leases, but it's not going to make a huge difference. Yeah. Do we want to talk valuation real quick? Yeah. And then one reference, we talk about dilution. a lot. I just want to put some numbers in people's heads. Their total shares outstanding right now are about 600 million. And as of last quarter, they had 81 million in total anti-dilutive securities, 35 million from stock options and RSUs, 18 million from convertible notes, and 27 or 29 million, excuse me, 28 million from common stock warrants. Didn't investigate the common stock warrants, but the other two are pretty straightforward. So

expect solution coming down the line. But yes, let's move to valuation. Keep it quick. Market cap, 47 point something billion here. Enterprise value about 48 billion. Let's just call it $48 billion. And the two numbers I'm looking at, because operating income is negative, free cashflow, I guess we can use EV to free cashflow, 300 plus, but it's not really going to be useful. It's really easy to gross profit. And that's the only one I think that's any sort of useful. And then you have to project what the true margins are going to be over the long-term. Easy to gross profit is 8.7. Not too expensive, not too cheap either. But let's move on to anecdotal evidence. Ryan, what do you got? I don't use the Cash App anymore. I used to.

um and i re-downloaded it this morning and it's cool all the stuff they've added i think if i if i wasn't sort of grandfathered into the bank my parents were using this would probably be one of the first places i'd explore trying out i wish i had do they not have good connectivity to the the cash app or what do you mean like i don't know it's just like not too hard to connect your bank usually no it is i would just it would be my it would maybe function as my primary bank uh right right except for the fact that they're they are missing some features like a credit card um but but potentially that gets rolled out either way basically if i didn't have access or easy access to the traditional banking system i think this would be one of my first spots or if i used

it like regularly like i use venmo that that potentially uh i'd still have it downloaded as well um i also downloaded title looks cool but i mean it's just too far behind in terms of adoption i think to compete with spotify yeah or apple music i've always thought of title as an art project which is not good for a public company i think jack dorsey basically paid 300 million dollars to be friends with jay-z yeah and he's gonna pay more over time because that unit loses money every year all right my anecdotal evidence i used to be a cash app user i used the cash card kind of while we were investigating you know buying this dog well i think it's after we owned it previously which has been for a few years now since we've owned it um i wanted to buy or excuse

me use some of their products just to get a nice feel you just use the cash card i used to love it because they would give me you know 10 off boost for you know for free when i was spending with the card which is great you know it's better than anything you get on a credit card i was like all right this is awesome i guess those were a little unsustainable because you're only you're earning 2.75% when reality actually lower on those credit card fees. So they stopped offering them. And then I didn't really find any uses for it anymore. Didn't want to do Bitcoin trading, didn't want to do stock trading on there. I have a bank account that works fine. So I ended up stop using it. And I guess I just stopped giving money in the account. However, though, looking at those

numbers that Ryan mentioned, looking at the Cash App numbers over the last three years, I will think I'm an exception here. So I wouldn't take that too much to heart. I mean, the business is still doing phenomenal. Future growth opportunities though, Ryan, what do you have for us? Mine's the combination of the Cash App Pay and the Cash App Card. So for starters, you've talked about it here. The Cash App Card or the Cash App Card is growing pretty quickly. 36% of Cash App monthly active users are now monthly card users as well. That It was just 29% last year, and the overall user base has grown, too. I think during the invest day, they said cash card users drive five times as much gross profit as a non-card user.

So the higher the penetration rate of card acceptance or adoption among the cash app users, the better. um then just beyond the cash card cash app pay users um are it's it's kind of new but it's a good way to add further transaction revenue um on on the cash app so for those that don't know cash app pay i already kind of described it but it allows you to pay any square merchant directly from your Cash App account. It can be physical or digital. They also are trialing this with some non-square merchants. It'd be interesting to see if this gets well adopted. And then there's an interesting anecdote from the conference call. 60% of Cash App pay volumes are now from customers who aren't active in the Cash App card. So it's additive. It's incremental. It's not just

kind of cannibalizing the the card transactions it's really adding new transactions that uh that weren't previously made on the cash app yeah really i mean the execution of cash has been great and it seems like they're trying to you know they're great with cards right but they're trying to embrace some of these non-card or you know card not whatever you hold your phone over to something and it's qr code or they're holding it over and it kind of you know pays for you which is you know apple pay google pay and yeah there's usually a card connected to that um and venmo i guess has tried to do this as well it's seems like and it's it's not really you know gotten mainstream in the united states but it seems like there's going to be steady growth

through these products because over time phones are just much you know everyone's got their phone on them it's much easier to to pay or even with your watch um because taking the phone out of the pockets too much it looks uh snazzy though if you just pay with your watch i gotta say you do look cool uh okay mine all right is i mean there's plenty here like for one if you watch their investor day or listen to them there are plenty of growth opportunities that they talk about for shareholders but i don't believe in a lot of them so i'm going to choose one i think is more important for their future growth and mode expansion and it is upselling square business customers to more of their products. They've seen consistent traction with this over time.

There's a nice slide from the investor today that shows gross profit from customers who use four plus products at 40% of overall gross profit, up from less than 10% in 2015. And looking at the chart, I think it changed or got better every year from 2015 to 2021. And I'm assuming it got better in 2022 as well. This will not only be a growth driver, but I think also drive gross retention for these businesses because if you're using more of the products, it's going to be harder to switch. We increase those switching costs. And there are economies of scale eventually where only few people out there can really offer all the tools that Square can offer. It would take many, many years to copy them. Okay. Highlights and lowlights. Ryan, what do you like?

What do you dislike here? I'm assuming, and these ones might be more because we're going to agree pretty heavily here. I think we might have a lot of the same things. Yeah. I mean, the execution at their two core services have been really exceptional. The unit economics at Cash App are just incredible. I mean, Cash App is an absolutely wonderful business. According to Block Management, it costs about $10 to acquire an active Cash App customer. And within three years, those customers contribute $60 in gross profit on average. So certainly-

Not bad. Yeah, great economics. And then- For reference, banks can be upwards of $500. Yeah, I think the average is like $200, but yeah. Or $200, was I saying $200? They had a slide where theirs was tiny, the other one was super big. Either way, that's a very impressive comparison.

The other highlight for me, the execution at Square has been really good. I think that move up market towards larger customers and then the good adoption of additional services, so number of customers using multiple products, not only makes the business stickier because they rely on Square more, but by moving up market, there's less natural churn from business failures because those are larger businesses theoretically attracting more money. So there should be less, I think, bankruptcies. So that could lead to higher gross retention as well. So highlights are basically those two businesses. Lowlights for me, this won't come as much of a surprise, but Bitcoin, I have, I guess, two gripes here. I have a hard time measuring the value of obviously some of those Bitcoin initiatives that Dorsey has tried out. I don't know how much they're wasting, I mean, spending there.

But the other part is he seems fixated on making it a sort of a centerpiece of some of Block's other services, which is the more concerning part. If you go to Cash App, you can look up Bitcoin boosts or go check it out. It's basically they'll give you I can go look at it right now. I think if I spend like $50 or something at a grocery store, they give me $10 in Bitcoin back. and then i just take the bitcoin and transfer it straight to dollars you're not understanding the ecosystem ryan they're just getting money away it's really stupid but the um i guess it creates more transaction volume and i think i just picture like him at the offices like every time there's a new product him thinking like all right how do we how do we get bitcoin involved here how does

this benefit bitcoin and it's just like i don't know i think it's inhibiting real growth there um the other part and this is maybe the thing that frustrates me the most and it's just my general gripe some of their financial reporting feels pretty dishonest um so in the conference call they said we delivered strong profitability during the quarter with adjusted ebita of 327 million dollars over the last year stock-based compensation grew by 60 percent um and it is like i want to say it was like 250 million dollars in stock-based compensation out of the 327 million adjusted ebitda they also have real real depreciation costs that they back out they had they backed out 23 million dollars in acquisition integration costs because i guess those aren't

real um which that i mean that's a huge that's a cost that's a real cost and they backed out bitcoin impairment losses they basically backed out all their costs yeah i mean acquisition is fine but bitcoin because acquisition is fine well i mean potentially one time they could do it they could just have more acquisitions and yeah i mean you want to know what that was just feel like you know when i look at that adjusted ebitda sort of uh reconciliation or whatever every time i just kind of roll my eyes like that's you know that's not they said this is we delivered great profitability those were costs that you incurred you didn't deliver great profitability so either to me this is kind of intentionally misleading or my bigger concern

is that management general genuinely treats this like true profits yeah i don't know how they because they don't they have no incentive to do adjusted because they don't get paid on it so it's weird that they fixate so much on that uh yeah i don't know it's hard i mean yeah and yeah it's one of those just with the adjusted habitat just ignore whatever they state that just kind of look at the other numbers um highlights for me cash app as well kind of we looked at you know when we looked at the three years ago the thesis was they would take you know peer-to-peer payments and add on more monetizable features this definitely occurred and now they've reached a point where they have send which is peer-to-peer payments which is cash app card

or yeah cash card or cash app card and cash app pay and then savings as kind of the third pillar direct deposits stocks even bitcoin i guess even though it's you know we think it's lame now they're trying to add on even more stuff which is kind of a shopping feature i think or a shopping pillar they have the discover tab and then all the assets they brought over from after pay i think there is some potential there but still tbd um second one durability of the square business seems really strong and i there's always pushback on square that is a commodity and i just think they're better at uh they're just better at all the uh the products that they do and i don't think that's a moat but the fact that people say that

that card reader is just a commodity is really not true anymore uh third one is the young in executive terms management team everyone i think is below 50 or maybe one person's over 50. and over time i think it's shown that they've been able to act with you know agility and act quickly I have some lowlights kind of on the flip side of that, but I think it comes with benefits as well. And then fourth one, the international growth has been phenomenal with a gigantic opportunity ahead. So I think there's just a lot to like there. Lowlights, purchase of Tidal. We've talked about this already. Purchase price was $300 million, but could end up really costing them like $1 billion in adding up the annual losses. They're in the 30s on the audio app store charts

right now and Spotify, YouTube Music, Apple Music, probably the top five. So they're not have been close here and nothing's changed since they talked about it. And I think with Jay-Z on the board now and Dorsey being friends with them, it's unlikely they will sell it. It's not going to happen. Second, Bitcoin investments, you already talked about that. On the young management team, they seem to be caught up in a lot of new projects and make a lot of irrational decisions sometimes. Was the afterpay acquisition a good fit for them? Yes, it was a good fit. Was it way overpriced? Yes. And you timed the top of the bubble. Was title a dumb move that should have been contemplated a bit longer? Yeah, it probably should have been contemplated by the board of directors. Was all the crypto stuff a bit much? Yes. Like some companies invest in crypto or explore it, or maybe they all say they're exploring crypto just to make the investors, the analysts happy when the Bitcoin prices are mooning, but they took their whole identity and renamed themselves blocks. So it's just too much.

And I think an older, more seasoned management team would probably not get into these hype cycles. But again, there's positives to that. But that's all I have. Bull case, Ryan, as we wrap up here for you. Change to the share structure. Yeah, that'd be huge. If that actually happened and votes went one to one,

it would allow someone to step in, really let the cash app economics show, cut the Bitcoin costs, cut the title costs. Acquisition, excuse me, an activist would be in there the next day. Yeah, I mean, it would be

an incredible, I mean, the stock would jump, obviously, I think. But if the management team stays in place, that's currently there, that I think they'd have to rein some costs in.

But I just want to put some numbers down for context. If over the next five years, gross profit grows by 10% annually and 20% of every gross profit dollar turns into free cash flow which is about how much turns into adjusted ebitda right now um block would generate just under two billion dollars in annual free cash flow ev is just under 50 billion so and you know 10 10 growth 10 gross profit growth 20 of gross profit goes to

free cash flow so honestly i think those are probably maybe i'm conservative on the gross profit assumption here but uh 50 billion dollars on two billion dollars 50 billion market cap today versus two billion dollars in theoretical free cash flow five years from now i think you have to assume that gross profit grows a lot faster and um they generate more free cash flow uh than i'm projecting here because those returns would not be great yep i think you had to expect probably 20% or higher. But hey, in the past, on my bull case, it's been higher. 34% compound annual growth rate since 2018 for gross profit per share, and that is per share. So gross profit in general has been even higher. Yeah, cash cap's not going to grow as quickly in the future, but still,

I think it's doable. And yeah, you just get expenses and headcount rationalized. I think if you get that, EV to gross profit is a little below nine. I think if that happens, and it would be very hard to lose money over the long term. I think it'd be really hard. Now, is it going to have 15% compounded stock returns on the upside? I don't think so, given the valuation today, unless they really execute and say, buy now, pay later, or something like that. All right. Your bear case, Ryan, as we close out. Yeah, just poor capital allocation. um i worry this is just one of those businesses where it never truly generates cash like i don't know how much is a business like that worth

maybe cash app continues to grow but maybe the expenses or their random bitcoin investments continue to grow as well that's like a concern to me and i don't think it'll ever change unless dorsey's out um i put this this really rhetorical question here but if dorsey's such a believer you know when you when you watch the investor day it's him kind of in this like monk mode where he's got that long beard he's in this like really light wood colored room just kind of zen and he's like i'm a bit you know believer in free markets and everyone should participate and it should be you know this total merit democracy but if you're a believer in that and everyone's equal and you're open and you believe in fairness for all why aren't all shares equal to one vote well

i mean exactly it's he only wants the fairness for all of it if it's to his advantage it seems like for me um i think if if he changed that uh and the share structure was changed i would be i would certainly consider jumping in here yeah for sure the we used to love Jack for a lot of the things they did because they were so innovative as a company and they still continue to be innovative, but I think they've just lost their way from our perspective. Maybe they're right. It's not guaranteed that we're right here, that they're wrong. But yeah, that's the big bear case for me too, is mismanaging expenses, more poor acquisitions. It seemed like they do about one every couple of years at least. And then these

investments i'm saying quote unquote it's a bitcoin and bitcoin related products the thing is though the my bear case is you know these things have occurred all those three things that i once said they've occurred for the last five years so why should investors expect them to change over the next five i just don't get it if someone does something in the past you should really bet that it's gonna continue to happening happen at least in the near future it you know they brag a lot on the investor day they defended themselves in the proxy statement versus that shareholder by saying that gross profit has grown at an incredibly fast pace which it has but if it never gets turned into bottom

line consistent cash flow generation uh and let's not say they do a billion whatever in sbc which has just gone off the chain it's not you know it's not the returns aren't going to be positive they're not going to be good so yeah that's my worry like do they really measure themselves with that yeah i think they profit for sure because they can put as much as they want to operate expensive if that's how they measure themselves yeah i know i i it's because that's all that they talk about that a ton well they talk about gross profit not gross profit per share which i guess is even worse but yeah i fear that they just want to be large and they don't care about optimizing for shareholders which you know some fear we have with a lot of companies but i

think but this one especially it's a big concern okay wrapping up more or less interested i think ryan you're in that we're in the same boat here right i'm more interested if the share structure changes yeah i'm more interested i would be thoroughly considerate i just can't do it once he's there yeah i think either dorsey you really have to see him say i was wrong about bitcoin and like kind of you know really admit that it's over i would actually love bitcoin to go to zero so he would forget this but it kind of say like we're not doing any crypto again it's all going to be whatever i doubt he's going to do it because he seems so it's religious for him and they changed this dual class structure i think it'd be great it'd be great if he's gone it's

super interesting probably not at this price but it's definitely going on the watch list for sure i'm the same but okay that's going to do it for this episode remember subscribe to the newsletter to get show notes charts everything great for this episode uh it's in the show notes two of these podcast links, the links there, you just click on it and subscribe. You'll get them in your email inbox, or you can search Chit Chat Money on Substack. If you like watching these episodes, seeing any screen shares we do, you can do that on YouTube or Spotify. And if you enjoy the show, the easiest way to support us is to give us a review on either Spotify or Apple Podcast. It takes five seconds out of your day. Remember, we are not financial advisors. Anything we say

on this show is not formal advice or recommendation. We are general partners at Arch Capital and clients may hold securities discussed in this podcast. Thank you all for listening. We'll see you next week with American Express, right? That is correct. American Express going for the older company that has done extremely well over the long term.

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