Block: Stocks are undervalued even without Bitcoin (NYSE: SQ)

Block, Inc. (NYSE: SQ) is a payment facilitator with revenue mainly split into two main segments, Square and Cash App. It has high revenue growth with a 3-year CAGR of 66.50% and a 5-year CAGR of 56%. However, despite the high revenue growth, the company the share price fell 73.52% in the past year. To understand one of the potential reasons why the company has high revenue growth but a falling share price, we analyzed its P / S versus its competitors to determine the intrinsic value of the company.

Low P / S ratio despite high 5-year revenue CAGR of 56%

Average P / S	3 year	5 years
<20%	5.63x	6.42x
20% -40%	4.21x	3.98x
> 40%	6.60x	6.95x

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Source: Cerco Alpha, Khaveen Investments

The chart above compares fintech companies based on CAGR and 5-year revenue P / S.

We have colored some of the companies based on their subsectors:

• Red: Payment Facilitators (Bill.com (BILL), Block, Adyen (OTCPK: ADYEY), Shift4 (FOUR), PayPal (PYPL))
• Green: Card Networks (Visa (V), Mastercard (MA), American Express (AXP))
• Yellow: Financial and accounting software providers (HealthEquity (HQY), Xerox (XRX), SS&C (SSNC), Intuit (INTU), Envestnet (ENV), Guidewire (GWRE), SimCorp (OTCPK: SICRF), Temenos (OTCPK: TMNSF)), Black Knight (BKI))
• Brown: Merchant Acquiring (Fiserv (FISV), FIS (FIS), Global Payments (GPN), StoneCo (STNE), PagSeguro (PAGS))
• Blue: BNPL (Says (AFRM), Zip (OTCPK: ZIZTF))
• Viola: online loan (Lufax (LU), LendingTree (TREE))

Based on our observations, 13/28 companies are in the low-growth segment of revenue (<20%).

Bill.com has the highest P / S 24.32x, which is its highest growth rate among all fintech companies. After Bill.com, the company with the next highest growth rate is Affirm (81.79%).

While all 3 companies in the card networks subsector are in the low-growth segment (<20%), Visa and Mastercard are the two fintech companies that have the second highest P / S among all companies. This is likely due to the fact that they are not only the 2 largest fintech companies by market cap, but also the 2 of the largest companies in the world, with a Visa market cap of $ 445.40 billion and a market cap of $ 445.40 billion. Mastercard of $ 333.87 billion as of July 2022. These two are outliers, which we have excluded from our average P / S calculation.

Other companies with high growth rates (5-year revenue CAGR) include commercial buyers StoneCo (48.55%) and PagSeguro (52.01%). Although they have a high revenue growth rate (> 40%), their valuations are relatively low (compared to the average commercial buyer’s P / S of 2.28x and the average high growth P / S (> 40%) 6.95x This could be due to the market price at a discount due to the fact that they are Brazilian shares.

Finally, Block has a low P / S (1.94x) although it has a high 5-year revenue CAGR (56.03%). To understand why this was the case, let’s look at Block’s revenue breakdown to better understand the company.

The reason for the low P / S is due to the inflated Bitcoin revenue

Revenue (million dollars)	2019	2020	2021
Based on the transaction	3.081	3,295	4,793
Subscription and service	1,031	1,539	2.710
Hardware	85	ninety two	146
Bitcoin	516	4,572	10,013
Total	4,714	9,498	17,661

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Source: Block, Khaveen Investments

Gross margin	2019	2020	2021
Transaction based	37.08%	41.83%	43.06%
Subscription and service	76.89%	85.15%	81.70%
Hardware	-64.16%	-57.49%	-51.83%
Bitcoin	1.59%	2.12%	2.17%
Total	40.09%	28.78%	25.03%

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Source: Block, Khaveen Investments

Based on the table above, Bitcoin was the largest segment of the company (56.7% of total revenue) in 2021. Furthermore, we compiled the company’s gross margin and found that Bitcoin’s revenue has a gross margin. of only 2.17% compared to its total gross margin of 25.03% in 2021. Based on its annual report, Block defined Bitcoin’s revenue as

Sales amounts received from customers are recorded as revenue on a gross basis and the associated bitcoin cost as the cost of revenue, as the Company is the principal in the bitcoin sale transaction.

Therefore, we believe the company’s low P / S is due to its total revenue being inflated by Bitcoin’s revenue because they are recorded by the company on a gross basis and have very low margins.

Comparison	Revenues 2021 ($ mln)	P / S
Bitcoin included	17,661	2.41x
Bitcoin excluded	7,649	5.57x

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Source: Block, Khaveen Investments

We calculated Block’s P / S excluding its Bitcoin revenue and came up with a sales value of $ 7,649 million in 2021. Based on its market capitalization of $ 42,590 million, we then calculated the P / S and we came up with a P / S of 5.57x compared to the previous P / S (2.41x) which supports our belief that its total revenue is actually inflated by Bitcoin revenue.

Expected revenue growth excluding Bitcoin revenue

The analyst’s revenue growth consensus is volatile, where revenue growth is projected to only be 0.11% in 2022 and increase to 20.40% in 2023. We believe this is due to the volatility of the bitcoin price. which affects the company’s Bitcoin revenue.

As shown in the table below, the company’s Bitcoin revenue fell by 50.70% from the first quarter of 2021 to the second quarter of 2022, while all other subsegments had increased.

Block ($ mln)	1st quarter 2021	1st quarter 2022	% Growth on an annual basis
Square
Transaction revenue	867.77	1,123.73	29.50%
Revenue based on subscriptions and services	121.09	282.65	133.42%
Hardware revenue	28.79	37.33	29.66%
Cash App
Transaction revenue	91.56	109.24	19.31%
Revenue based on subscriptions and services	436.59	622.31	42.54%
Enter bitcoins	3,511.07	1,730.79	-50.70%

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Source: Block, Khaveen Investments

So, to estimate more reliable and less volatile revenue growth for the company, we projected its revenue growth by excluding Bitcoin revenue.

Block ($ mln)	2018	2019	2020	2021	2022F	2023F	2024F
Square
Transaction revenue	2,429	3.008	3,061	4,383	5,781	7,521	9.794
Growth %		23.9%	1.8%	43.2%	31.9%	30.1%	30.2%
Revenue based on subscriptions and services	222	369	376	664	775	903	1.053
Growth %		66.1%	1.9%	76.5%	16.6%	16.6%	16.6%
Hardware revenue	69	85	ninety two	145	159	174	190
Growth %		23.4%	8.5%	58.2%	9.4%	9.4%	9.4%
Total square	2720	3462	3529	5193	6,714	8,598	11,037
Total growth of the square		27.3%	1.9%	47.1%	29.3%	28.1%	28.4%
Cash App
Transactions and subscriptions and service-based revenues	264	589	1,397	2.303	3,940	6,575	10,771
Growth %		123.6%	137.1%	64.9%	71.1%	66.9%	63.8%
Enter bitcoins	167	516	4,572	10,013	6.920	7,411	7,938
Growth %		210.2%	785.2%	119.0%	-30.9%	7.1%	7.1%
Total Cash App	430	1.106	5,968	12,316	10,860	13,987	18,708
Total growth of the Cash app		157.1%	439.8%	106.4%	-11.8%	28.8%	33.8%
Postpaid revenue (including synergies)					1,322	2,266	3,602
Total combined revenues	3,150	4,568	9,498	17.509	18,897	24,850	33,348
Total combined revenue growth%		45.0%	107.9%	84.3%	7.9%	31.5%	34.2%
Revenue (excluding Bitcoin)	2,983	4,051	4,926	7,496	11.977	17,439	25,410
Growth %		35.8%	21.6%	52.2%	59.8%	45.6%	45.7%

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Source: Block, Khaveen Investments

Previously, we projected revenue by Square (Seller) and Cash App segments by all business segments. We have updated segment revenues based on the latest figures from 2021 and updated some of the expected market CAGRs for the sub-segments.

Under the Square (Seller) segment, we updated the market forecast CAGR data and achieved higher projected subscription revenue growth at a 16.6% CAGR compared to the previous 14% CAGR. In terms of hardware revenues, we achieved lower forecast revenue due to an expected market CAGR that was 9.4% lower than the previous CAGR used (11.2%).

We achieved higher revenue growth for the Transaction segment in 2022 (31.9% vs 17.7% previously). This is due to an increase in our projection of the growth rate of Block’s share of the seller’s GPV as a% of the total GPV (from 17.6% versus 6.5%), as we have estimated that Block has gained market share. of digital payments last year.

In the Cash App segment (excluding Bitcoin), revenue growth forecast for 2022 decreased from 76% to 71.1%. This is due to a decrease in the projected growth of additional users from 8.3 million previous users to 8.2 million users as we have updated the 2021 users based on the actual figure, which is lower than the predicted users for 2021. previously.

After excluding Bitcoin revenue for non-inflated revenue, we got a 3-year average revenue growth projection of 50.4% versus 24.5% (including Bitcoin). This shows that Bitcoin’s revenue lowers our future revenue growth projection due to the lower expected Bitcoin growth rate (7.1%) in the future.

Risk: lower afterpay growth

The future growth of Afterpay (acquired by Block) may be lower due to the high competitiveness in the BNPL market which could affect Block’s future revenue growth. This is shown where in December 2021, Afterpay’s download growth was only 10% yoy compared to 130% yoy in December 2020. In contrast, its competitors, Affirm and Klarna (KLAR), had a much higher year-on-year download growth in December 2021 at 90% and 70% respectively.

Verdict

Average P / S	3 year	5 years
<20%	5.63x	6.42x
20% -40%	4.21x	3.98x
> 40%	6.60x	6.95x

Click to enlarge

Source: Cerco Alpha, Khaveen Investments

After excluding Bitcoin sales, our projections for Block’s 3-year average revenue growth came in at 50.4%, which places it in the high-growth segment (> 40% CAGR). We then derived Block’s price target of $ 124.41 using the 3-year high growth P / S segment (6.60x) and our 2022 revenue projection of $ 11,977 million. Our price target of $ 135.07 represents a 53% upside compared to the current price, and is higher than the analyst consensus of $ 118.38.