(Dec 13): Earlier this month, Jack Dorsey, co-founder and CEO of financial technology, or fintech, giant Square triggered quite a kerfuffle when he announced that he would take three to six months’ leave travelling across Africa next year. Dorsey, who recently spent time in Nigeria, Ethiopia and Ghana, is also CEO of social network Twitter and the only person who runs two listed tech companies. Shares in both firms plummeted as talking heads and corporate governance experts took to financial media, and even Twitter, to voice their concerns. Although the two stocks have since rebounded, the episode inadvertently highlighted Square’s long-term potential as a huge disruptor in emerging markets from Africa to Latin America to Asia, where financial infrastructure is less developed even though the bulk of the firm’s revenues currently come from the US.
Founded by Twitter’s co-founder and CEO Dorsey and Jim McKelvey at the height of the global financial crisis in early 2009, San Francisco-based Square now has a market capitalisation of US$29 billion ($39.4 billion). The company started out peddling a small squarish card-reader that plugs into a smartphone or tablet, giving small merchants an easy way to accept credit and debit cards. Its market value is now twice that of troubled German financial behemoth Deutsche Bank and slightly bigger than that of State Street Corp, which owns the 14th-largest bank in the US and is the world’s largest custodian.
Having caught traditional payment-processing companies off-guard, Square has since expanded into a major fintech firm with a cohesive commerce ecosystem that helps sellers start, run and grow their businesses, Dan Dolev, payments analyst for Macquarie Securities in New York, tells The Edge Singapore in a recent interview. Essentially, Square combines sophisticated software with affordable hardware, which enables payment solutions for sellers, including point-of-sale hardware and software. Now, it is using its Cash App to transform itself as a real payments disrupter.
Think of Square as a payment software company that can monetise various parts of a growing ecosystem that it is creating. It could be your payroll or inventory management; as a small business, you can even build a loyalty programme on its software. The payment upstart is trying to build something like a bank that includes a whole range of transactions that you currently use a bank for.
Square is among a handful of fintech firms — including PayPal, Stripe, China’s Alibaba Group Holding-affiliated Ant Financial and Europe’s Adyen — that are disrupting the payments landscape and emerging as low-cost competitors to banks, incumbent credit card processors such as Visa and Mastercard and, increasingly, other financial services firms such as online brokerages. There is also a bunch of digital wallets such as Apple Pay and Google Pay. Facebook recently announced its own wallet Facebook Pay on top of its ambitious plan to introduce a stablecoin called Libra, which has been widely panned.
Cash convenience
Yet, Cash App has been gaining mind share or search share on Google over rivals such as PayPal’s Venmo. Cash App provides a set of financial tools for individuals to send, spend and store money. With Square’s Cash App, you can send and receive P2P (peer-to-peer) payments, receive direct deposits and even fund your Cash App account with your bank account or debit card. On Venmo, you pay nearly 1.5% on most transactions but, on Cash App, you can immediately transfer money for free to your friend if he paid for your coffee or lunch. For other transactions, you pay up to 1%. It is more popular in the southern states of the US, where unbanked and underbanked rates are the highest. “People are using it as their primary bank account and, in some cases, it’s their only bank account,” CEO Dorsey said recently, arguing that Cash App has become its users’ primary financial hub.
While Apple’s widely used digital wallet Apple Pay links your credit card, which allows you to tap and pay at a point of sale, PayPal’s Venmo and Square’s Cash App are different. They enable the unbanked and underbanked population in the US — people who have just a low-tier, low-cost or no-cost account with a bank or financial institution that does not offer them a whole range of the financial system — get access to more services.
So, increasingly, apps such as Cash App are being used as a pseudo bank account. People can get paid by their employer via the Venmo or Cash App. They get an instant deposit on their app and gain access to that cash right away. It has become a very convenient vehicle for the under-banked to receive deposits and make payments, taking market share from pre-paid credit-card providers such as Greendot.
Cash App has grown exponentially from just US$1 million in revenue in mid-2016 to a US$635 million annualised run rate in the last quarter. Max Friedrich, a fintech analyst at New York-based, tech-focused fund manager ARK Invest, believes Cash App may now have more monthly active users than rival Venmo. Macquarie’s Dolev says revenues from Cash App could grow 60% to 65% next year and 50% in 2021, slowing to 40% in 2022. “Those are conservative estimates and I believe they could easily beat that,” he says.
Cash App currently accounts for just 25% of Square’s revenues. The rest of the revenues come from point of sale: Small and medium-sized businesses, mom-and-pop stores selling cupcakes or stalls in food courts take Square Cash payments instead of credit cards because it offers them analytics. You can tell them it might rain tomorrow, and that means more sales of umbrellas; so, they might want to stock up. Or, for a restaurant, fewer people dining means the owner might need fewer contract-worker waiters or kitchen help. It does this in real time and can save small businesses a lot of money or help them make more money.
Access to customer data
Square is already in the zero-commission online stock brokerage business. It was one of the first to offer fractional share purchases. So, instead of buying 100 share lots or, indeed, 1,000 share lots, as most people do in Asia, or a single share purchase in the US, Square allows customers to buy one-hundredth of an Amazon.com share for US$17.50, instead of the US$1,750 a share it was trading at this past week. Millennials do not want to buy a 100-lot share of e-commerce giant Amazon for US$175,000, but would not mind just one-hundredth of it. Fractional shares or fractional ETFs are what customers want, and Square has tapped the trend by giving them access to stakes in companies to build a portfolio of their choice. In the past, shares of many large companies were beyond the reach of small retail investors. Now, they are affordable for someone willing to skip a latte or avocado toast to start building a portfolio.
Although Square does not rake in much revenue from offering fractional shares, it does get access to a ton of customer data. “They are doing this to drive customer engagement on their Cash App,” notes Dolev. Fractional shares are an engagement enhancing tool that nurtures the ecosystem; they could either monetise it or get [customers] to use another service that they are monetising. Square is trying to build a sticky ecosystem and get economies of scale to compete against incumbent players such as banks, online brokerages such as Charles Schwab or E*Trade or payment players such as Visa or Mastercard. More downloads and more usage of Cash App helps Square grow its ecosystem and remain stickier and get it to its goal of making money down the road.
Edge over other lenders
Square is also in lending through merchant cash advance or short-term lending for small retail businesses. The edge that it has over other lenders is that, because it is at the point of sale, it knows in real time just how much cash is coming in and whether it is creditworthy. When Square lends, it can collect its fee, the principal and the interest directly at the point of sale before the borrower itself gets paid.
So, with its data advantage, as well as the fact that it is collecting the revenue on behalf of the merchant before debiting into their account, it essentially has a much lower default rate. This also allows Square to offer better interest rates than a bank might offer to small businesses. Not only does Square have real-time data about your business, it also has real-time data about other comparable businesses in your area, which in turn allows it to make more money from lending at lower rates and still boast lower default rates.
Square does not underwrite the debt itself and has no balance sheet exposure. It has financial partners who do that. Yet, payment players such as Square are exposed to a downturn because of their heavy exposure to brick-and-mortar retailers. In a recession, many small businesses tend to suffer and people tend to shop for the cheapest stuff online instead of going to their neighbourhood corner store.
With its recent acquisition of Weebly, Square now has a presence in market website solutions with its payment options built in, but e-commerce remains a small part of its total business. Although challengers are growing, new digital banks that do not have legacy systems are unlikely to derail the rise and rise of Cash App or Square, which is trying to morph into a digital bank itself. Long before the digital-only banks acquire scale, Square will be a player in its own right with years of relationships and data.
Having surged 11-fold from just under US$8 a share in 2016, Square shares plunged 50% to under US$50 last December. The stock is up 18% this year compared with 23% for its closest rival PayPal, 42% for Visa, 53% for Mastercard and 25% for the broader market gauge Standard & Poor’s 500 index.
“Emerging markets, particularly Africa, represent the future of payments,” says Dolev. Outside the US, Ant Financial and Tencent Holdings’ WeChat Pay already have a hammerlock on the China market, while local players such as PayTM are tightening the grip on India. In markets such as Africa, there is still an opportunity to build the business from scratch, and Square has the hardware, software and services that the region needs. The company could leverage its first-mover advantage in Africa, as well as crypto currencies, to build scale and become a dominant global player in payments.
Assif Shameen is a technology writer based in North America
