redesign | payments: Square’s IPO will be an interesting one to watch

Rakesh Agrawal is a payments expert. He has been widely quoted about the industry in publications such as Bloomberg Businesweek, The New York Times and appeared on CNBC and Bloomberg.

According to Bloomberg, Square has begun the process of an IPO with a confidential filing. (Allowed under the JOBS Act for companies with less than $1 billion in revenue for the previous completed fiscal year.)

Square has been widely considered a hot company. Part of this is due to the celebrity status of founder Jack Dorsey, who also co-founded Twitter. Its eponymous card reader is used by millions of small businesses, according to the company. (This should be discounted because there is no commitment; I’m technically a Square user, even though my Square sits in a drawer.)

There’s no doubt that Square has simplified and demystified the bewildering payments process for small businesses. Instead of dealing with byzantine rates, statement fees and minimums, Square charges a flat 2.75% of each transaction.

But that also creates a business problem for Square: most transactions at coffee shops and food trucks result in a loss to the company due to the relatively high fixed cost of credit and debit transactions.

Square claims $30 billion in processed transactions. If you’re generous and assume all of that volume is at the 2.75% rate, that translates in to $825 million in gross revenue. But the vast majority of that goes straight out the door to payments processors.

In the credit card industry, success is measured in “bps,” or basis points. 100 basis points equals 1 percent. Apple gets 15 bps per transaction for Apple Pay. Square should be getting significantly more. But, unlike Square, Apple likely isn’t on the hook for fraud losses.

The S-1 won’t be available to the public for some time, But when it comes out, here are the key things to look for:

  • Merchant mix. The type of merchant affects Square’s profitability. Food trucks and coffee shops are bad. Doctors, plumbers and contractors are good.
  • The median ticket. The lower the median ticket, the worse things are for Square. A number in the $10-$20 range is disastrous. Above $100 is great.
  • Credit vs. debit mix. Credit transactions are substantially more expensive to process.
  • Transactions per merchant. This will likely show that the vast majority of Square’s “merchants” are people like me with Squares sitting in drawers.
  • Fraud losses. Fraud makes or breaks a payments business. In the early years, PayPal nearly went bankrupt because of fraud.
  • Revenue from non-transaction products. Many of Square’s widely publicized initiatives are failures: Square Wallet, Square in a Box, Square gift cards, Square Cash. For Square to be a business that approaches its valuation, it will need to develop significant revenue from ancillary products.
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