| 2024 | 2025 | ||||||
| Price: | 69.69 | EPS | 0 | 0 | |||
| Shares Out. (in M): | 616 | P/E | 0 | 0 | |||
| Market Cap (in $M): | 42,910 | P/FCF | 0 | 0 | |||
| Net Debt (in $M): | 0 | EBIT | 0 | 0 | |||
| TEV (in $M): | 41,489 | TEV/EBIT | 0 | 0 | |||
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Company Name: Block Inc. (Block) (ticker: SQ)
Block has been written up on VIC 6 times previously and is trading around the same price as the most recent write-up by alum88 which was posted in January 2023. A lot has happened since that time in terms of a cultural and organizational shift within Block and I think it is all very positive. In particular I think the potential emergence of the Bitcoin business as a very big business for Block is new and exciting.
Block is a widely known name yet I think it is also a misunderstood name given it’s history and the presence of Jack Dorsey whose celebrity and involvement with Twitter tend to colour peoples’ views of the company. There is also Block’s devotion to Bitcoin and the Bitcoin ecosystem which can be controversial (though I believe this will be an asset to Block and a driver of shareholder returns in the future - see below). Block’s business currently consists of 4 different business units, which they call ecosystems:
Of these four ecosystems, Square and Cash App are by far the most important as Tidal and the Bitcoin Business generate minimal gross profit at the moment.
Block’s stated goal from their investor day is to build an “ecosystem of ecosystems” which means that they are trying to build closer connections between the various Block ecosystems. This has advantages for both the customer and for Block in terms of competitive positioning and efficiencies. I think Block can (and does) differentiate itself from its competitors because of its collection of ecosystems.
Investment Thesis
Block has traditionally been able to compete because of the speed that they were able to innovate and develop new products which were valuable to their customers. From the first card reader, Block has been bringing new product innovations to market at a speed which their competitors have found hard to match. A more recent example of this is Cash App’s rise to prominence relative to the early industry leader in peer to peer payments, which was Venmo. Cash App has consistently added more products and services to Cash App at a pace which is faster and more consistent than Venmo, and as a result, Cash App is now the market leader in terms of revenue and profitability, as well as user growth, despite Venmo having a huge head start.
This culture of innovation is well documented in the book, “The Innovation Stack”, which was written by Block co-founder Jim McElvey.
The second competitive advantage that Block has built is their collection of ecosystems, and specifically developing Cash App to complement their pre-existing Square ecosystem. While these are two separate and distinct businesses, they do have lots of areas where they cross-connect. These cross-connections can create a lot of value and efficiencies for Block’s customers and for Block itself.
Block has also benefited from a strong emphasis on great design. Block’s original card reader was once exhibited in the Museum of Modern Art, and Dorsey is a strong advocate for great looking products in addition to products that perform well, along the lines of Steve Jobs with Apple. This has usually resulted in Block producing products that are more aesthetically pleasing then their competitors.
Block participates in industries in finance and banking where there are two groups of competitors. The vast majority of these markets are held by old incumbent players like major banks and financial institutions. On the other side of the market is newer fintech players who were founded around the same time as Square or slightly after. I believe Block has advantages against both which will allow it to continue to earn more market share in the various markets it competes in. These advantages are:
In this way Block is somewhat unique in being able to offer the best of both worlds. In addition Block’s ecosystem of ecosystems model, their devotion to fast innovation, and their emphasis on great design, give them a distinct competitive advantage in the various businesses they compete in. For these reasons I think it is likely they will continue to take market share from legacy financial businesses, and perhaps as well as from fintech competitors. In addition their new Bitcoin division is just starting to develop into a very strong new business which holds lots of future potential, none of which is being priced into the stock price today.
In the past 2 years, Block has demonstrated a new emphasis on profitability, and cost consciousness. Block has committed to a goal of Rule of 40 (defined as Gross Profit Growth and Adjusted Operating Income Margin). In addition they have also committed to a hard cap of 12,000 employees for the foreseeable future. Earlier this year they also reorganized and simplified their executive org chart, to allow for a leaner model which will hopefully lead to greater speed and more effective decision-making. I like all of these moves and think that they will result in better execution going forward than the market is currently expecting.
As a result, Block’s continued execution, combined with a new commitment to fiscal prudence and shareholder returns, as well as a relatively inexpensive stock price, leads me to believe this is a great setup for shareholders.
In addition to this, Block is entering a new business in terms of manufacturing and selling Bitcoin Mining rigs and their various components. This holds the promise of being a very large business for Block given that the market is currently dominated by two Chinese companies who face geopolitical risks as well as restrictions on producing state of the art chips. Block has minimal geopolitical risks being US based and has access to TSMC to make their 3nm ASIC chips. These seem to be a durable competitive advantage which should lead to Block taking significant market share in this market.
History of the Firm
Square was founded by Jack Dorsey and Jim McKelvey in 2008. McKelvey was a glass artist who lost a sale because he was unable to accept credit card payment for a $2,000 glass piece he was working on. Based on this personal experience McKelvey had a eureka moment and worked with Dorsey to solve it. Dorsey had recently been ousted as the CEO of Twitter.
Their initial product was the iconic Square card reader. This product which was launched at a much lower price point and a cheaper service cost to competitors, immediately took off in popularity, especially amongst under serviced micro merchants. The Square Card Reader was so well designed it appeared in the Museum of Modern Art. This combination of great design, a low cost, and a largely underserved market led to very rapid initial growth, even without any marketing or promotional spend.
Square was one of the first “payment facilitators” allowed by Visa and Mastercard. As a result it was able to easily onboard new merchants. As opposed to the traditional model where card acquirers would underwrite merchants prior to offering them card processing services. This traditional process could take a long time and the simple reality was that many small merchants would never get through underwriting. By offering a simpler approval process Square was able to offer a lower pricing for the service as well.
Square’s business grew rapidly until 2014 when Amazon decided to enter the point of sale market. Like Square they offered to give their card reader away for free, but Amazon tried to undercut Square by lowering the service fee even lower than what Square was offering. The story was told in “The Innovation Stack”. Square faced the very tough decision on whether or not they should match Amazon’s pricing. In the end Square decided to do nothing and to not try to compete with Amazon on price. Amazon’s competition lasted only a year and after they eventually pulled the plug on their POS business, Amazon sent Square card readers to all of their former POS customers. Square was too tough for Amazon to compete with.
A big part of the reason that Amazon was unable to compete with Square is that Square had evolved beyond simple payment processors and was now offering a variety of different product offerings to their customers in order to create value. Square now offers an expansive suite of software and banking products and services which help bring a lot of value to their customers and also create a large lock-in with those customers.
In 2013 as part of a hackathon event Square launched Square Cash which later became known as Cash App. Square Cash was created originally around the simple function of being able to send cash through email. While Square grew without the benefit of network effects, Cash App definitely took advantage of network effects to grow rapidly. Every time a Cash App user sent money to a non-cash app user, that person would become a new user. As more people were added to the network, the network became more valuable. As the network grew Square kept adding new products and use cases within Cash App.
On August 1st, 2021 Square announced that they would acquire Afterpay, an Australian buy-now pay-later company. This transaction eventually closed in Q1 of 2022. Afterpay has subsequently been integrated into Cash App.
On December 1st, 2021, Square officially changed its name to Block. This change was meant to differentiate the corporate entity from the Square seller business. The change in the name acknowledges Block’s growth beyond the original Square business.
Square
Square started with offering payment processing for micro merchants and now offers a variety of services and products including:
Merchants usually have to find individual providers for all of these services and they are not integrated and they don’t function well together. By offering all of these services Square is making the merchants lives a lot easier and is making Square indispensable to their business.
Square’s offering also integrates third-party service offerings like social media or logistics in an easier way then if the merchant did it on their own.
The breadth of services can be quite differentiating from competitors. Here’s a personal anecdote in this respect. Our office is an area with a lot of older commercial buildings with a lot of smaller independent merchants. As a result I can see that a lot of them use Square payment terminals. In a conversation with one of these local merchants he said that Square would actually give advice to him on what the optimal operating hours would be for his business based on the traffic data Square had in the area. That’s a pretty amazing value-add that I don’t think you’re getting from many payment processors.
Another interesting service I noted was that employees of a Square merchant can access their earned wages before their actual payday by logging into the Square App and transferring up to 50% of their earned wages per pay period, with no cash hit to their employer. They can even transfer the money to Cash App for free, or to another linked account for a fee. I think this is a good example of the innovative products Block is offering that allows them to get ahead of competitors.
Traditionally cohorts have layered on additional services over time which is great for Block because it grows the revenue with their existing customers but also makes them more and more indispensable to the merchant. A merchant with 4 Square products is much less likely to switch then one with 1 product. This is the key concept behind the ecosystem of ecosystems approach.
Square’s avenues for growth come mainly from:
The moving up market strategy has had some challenges and as part of the recent reorganization within Block, there has been a renewed emphasis in building out the sales team. In that respect Nick Molnar, the CEO and Cofounder of Afterpay is going to lead the now centralized sales team across Block, including Square. Afterpay had a good sales team culture and the hope is that Molner will be able to bring that to Square in particular.
The reorganization has also been targeted to help reinvigorate the product pipeline and speed up the cadence of new product launches in Square. This appears to be returning early dividends as they recently shipped the new Square Orders platform with new offerings for merchants.
Cash App
Cash App started with peer to peer payments and like Square has now layered on a bunch of new products and services including:
There are now over 80 million annual actives on Cash App and 24 million monthly actives. Cash App continually ranks well in Appstore rankings compared to other financial apps. Once the customer downloads Cash App, they usually begin to start using more of the various services within Cash App over time.
The main driver of growth within Cash App aside from the growth in the number of users is the amount of money flowing into Cash App. With that said, Block has been focused on making it easier for Cash App users to bring money into the ecosystem. This includes:
By integrating Square and Cash App, Block is able to offer some unique value to both ecosystems which is a key differentiation from their competitors. Cash App in particular is a unique asset and Block should be able to leverage it in a number of ways.
Bitcoin Business
Block has been developing new products for Bitcoin since 2019. In October of 2021 Jack Dorsey announced that Block would explore manufacturing Bitcoin Hardware under its Proto business segment. Block has now developed a 3 nanometre (nm) ASIC chip for Bitcoin mining and they’ve already signed a deal with Core Scientific, a Bitcoin Miner, to deliver these chips for Core Scientific’s mining rigs.
Bitcoin Mining is currently dominated by two Chinese companies, Bitmain and MicroBT. They have over 90% market share with Bitmain alone having over 80% share. These two companies are both based in China and rely on Chinese supply chains which may lose access to the state of the art chip production in western countries. Even if that were not the case, Bitcoin miners are mostly located in the US or other western countries and are looking to diversify their supply chain to mitigate the risk of a single point of failure and geopolitical risk with China.
Block appears to be one of the first companies to be able to offer a 3nm ASIC mining chip whereas Bitmain only offers a 4nm chip currently. MicroBt appears to have a 3nm chip available as well through Samsung. Nevertheless using state of the art chip technology looks to be a key advantage that Block has in potentially being able to compete Bitmain and MicroBT and right now at least it looks like Block’s chips should have a performance advantage over Bitmain.
In April Jack Dorsey said that he believes that Block can capture the majority of the Bitcoin Mining rig market. This is obviously a very aggressive goal considering they are starting from zero right now. However the combination of:
Makes it possible I think for Block to take significant market share. I discuss what that might be worth below in valuation, but sufficive to say that the market is big and quite profitable.
Block also has a number of other products within its Bitcoin business but as of right now, Bitcoin mining chips and rigs are the only products that look like they could be a big business for Block in the imminent future. That may change in the years to come. One product that I think does hold some promise is their Bitkey product for self custody of Bitcoin. It is interesting though still a very small business relative to the rest of Block at the moment.
Industry & Competition
Block competes with both traditional finance companies and banks on the one end and with newer more nimble fintech players on the other end. Because of the variety of different products and services they offer it would be hard to parse out who exactly they are competing with in any particular product or service. However generally speaking they operate in very competitive markets. That being said, I think there are significant switching costs and so you can generate decent stickiness with your customers, even though it’s very competitive. As I’ve said, I think Block can win new business by offering a better customer experience with better design as compared to traditional banks and payment processors, while at the same time offering a more full suite of products and services as some of their fintech competitors. Once they have won the business and the customer has integrated more than one of Block products into their business, they will be quite hard for competitors to dislodge.
Customers
Block has a mission to bring financial services to the traditionally underserved or underbanked segments of the world. They started with processing payments for micro merchants and Cash App is also widely used by Gen Z people or Millenials who have little attachment to the traditional banking system. They’ve tried to move up-market in both Square and Cash App with varying degrees of success. I think the new focus on building out a sales team is going to help them attract larger businesses as customers. They’ve previously relied more on the products to sell themselves and I don’t think that works as well in big companies where the decision maker has to justify their decisions to their bosses. Building out a more robust sales team should allow them to compete on a more level playing field with these customers and Block will win a fair amount of business by virtue of having great products.
Cash App has a viral network effect which has helped its growth. It hasn’t grown as fast in the last year in terms of users but they are still growing and they are looking to capture more spend with their existing users. This has a long runway for growth I think and as wealth shifts from the Baby Boomers to their kids, Cash App will be in a great position to capture a lot of that shift.
Valuation
Block can probably be viewed as four separate businesses with four separate profiles of profitability and growth prospects. However at least as far as it relates to Square and Cash App, I think these businesses actually are more valuable when paired together by virtue of Block’s ecosystem of ecosystems model. So for the purposes of valuing Block I will treat them as one unit.
Block has previously guided to the fact that they will reach Rule of 40 by 2026 (Block calculates Rule of 40 as summing gross profit growth and adjusted operating income margin) and they believe they will be able to achieve 15% gross profit growth and 25% adjusted operating income margin by 2026. Let’s assume that they can grow gross profit for 5 years at a 15% CAGR. That would get them to $16.5 billion in gross profit by 2029. At a 25% operating income margin that would equate to $4.15 billion in operating income. I think it’s reasonable that Block could trade at a 15-20 times multiple of operating income in 5 years assuming it is still growing gross profit at double digit percentages. Paypal trades at 15 times operating income now and it is not growing as quickly as Block. But moreover I think Block should garner a higher multiple because of their entrenched ecosystem of ecosystems approach. That implies a 2029 valuation of between $62 to $83 billion (or an IRR of between 9%-15% from the current enterprise value of $41 billion). We’d have to assume that recently announced buybacks will offset stock based compensation over that time which I admit is a big assumption but is also very doable.
That’s a reasonable return but I view that as a conservative base case. In order to achieve it I think Block only needs to continue to execute on their existing Cash App and Square business and 15% gross profit growth does not account for a re-acceleration of growth created by:
all of which I think is likely. If they were able to execute on any of the three initiatives above, I think we could see 20% GP growth in line with the past 5 years. At 20% GP growth they would be doing $20.5 billion of gross profit in 2029. I also think they might be able to get up to 30% operating income margins on gross profit and if they can, that would imply $6.15 Billion of Operating Income. This implies a $92 - $123 billion enterprise value or a 17-25% IRR, just on Cash App and Square.
Now turning to the Bitcoin hardware business Proto. It is a very new business and the range of outcomes is wide. But let’s throw out some possible numbers. Manufacturing and selling Bitcoin mining rigs is about a $6.5 billion business in 2024 by some estimates. It seems likely that as the only American manufacturer of mining rigs that Block should be able to take a decent chunk of this market for simply mitigating geopolitical risks for American based miners. The size of the market is also likely to grow over time assuming Bitcoin becomes more valuable (some will disagree but I don’t think Bitcoin is going anywhere and as long as it’s around I think it will increase in value in fiat terms by virtue of it being a capped supply and by virtue of increasing demand through greater acceptance by the broader financial community). And that’s assuming Block’s rigs are just on par with the Chinese companies. I think there’s a good chance that Block will produce a superior product by virtue of having access to state of the art chip manufacturers and because Block at its core is a great hardware design company. If Block has the better hardware, I think that combined with the lower geopolitical risk means that Block will take a majority of this market.
For the sake of quantifying this, let’s assume they get approximately 1/3 of the overall market or $2 billion in revenue in 2029 using the current market size of $6.5 billion (i.e. no growth of the overall market). And then let’s assume they can get a 25% operating margin on that revenue (NVDA’s operating margins pre-2023 were consistently in the 25-40% range. I don’t know what Bitmain’s profit margins are but it was reported that their profit margins were as high as 65% in 2018 and if true that would be much more profitable than these modeled margins). That would equate to $500 million in operating income. That seems like that would command at least a 15 times multiple on operating income. So the Bitcoin mining business could be worth $7.5 billion or more to Block in 2029.
I think these Bitcoin assumptions might prove to be very conservative if the market size grows a lot or if Block is able to take a majority of the market share away from the Chinese duopoly, or if they are able to achieve a much better profit margin than what I’ve modeled. If they can take 50%+ market share and generate better margins, the Bitcoin business could be doing $4 billion of revenue and $2 billion in operating income on mining rigs in 2029. There are some bullish scenarios where I think the Bitcoin business alone could be worth more than the current EV by 2029.
Hard to be too accurate with our speculation at this point but given that we’re likely not paying very much for the Bitcoin business I think this is a nice free call option.
As far as TBD, the consumer based Bitcoin business (Bitkey) and Tidal are concerned, I don’t think I have enough information to ascribe any value to these businesses at this point. But I think Bitkey and TBD show some potential to be or to spawn big businesses in the future. Time will tell. One thing that has been consistent with Block is that they’ve been very good at spawning new businesses and increasing their addressable markets. This is another free call option that can’t really be quantified but I think probably will have some value.
Block also has a growing stockpile of Bitcoin which may become a large asset value if the Bitcoin price appreciates a lot. I wouldn’t ascribe much value to the balance sheet at this point for the sake of conservatism but it’s very possible there will be some value for shareholders in the assets on the balance sheet and this may be returned to shareholders through share buybacks.
Risks/Uncertainties/Reasons for Discount
SBC dilution
Deceleration in growth in Cash App and or/Square
Regulatory Risks
Summary
Block has a number of dynamic businesses with multiple avenues for growth and a reasonable valuation. In particular their potential Bitcoin mining rig business is being completely disregarded by analysts in valuing Block despite the fact that it is likely to generate hundreds of millions of dollars in sales in the next 12-18 months. This represents a great asymmetric opportunity for investors.
Catalysts
Further announced sales of Bitcoin hardware and more financial disclosure on this business.
Continued strong growth in Square and Cash App gross profit.
Continued improvement in margins.
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