Square's IPO filing comes as market for IPOs remains shaky
Payments startup Square Inc. filed to go public Wednesday, even as it grapples with mounting financial losses and an unusual corporate structure that requires its founder to spend part of his day leading a larger technology company.
Square said in Wednesday’s regulatory filing that it would offer up to $275 million in stock, a figure that could change leading up to the IPO.
The offering is seen as a harbinger for tech companies valued at $1 billion or more—Square was valued by investors last fall at about $6 billion.
Most of these highly valued companies have stayed away from the IPO market with ample private capital available—in fact, there have been just 22 tech IPOs through the third quarter this year, compared with 53 through the third quarter of 2014, according to Dealogic.
Recent sharp stock-market swings have deterred some firms from pursuing public offerings. The Square filing came as two of the year’s biggest IPOs ran into trouble. Supermarket operator Albertsons Companies Inc. delayed its IPO plan, according to people familiar with the offering, while payment-processing company First Data Corp. priced its IPO below expectations.
San Francisco-based Square, meanwhile, is hewing closely to a script followed by other Silicon Valley technology firms: swelling losses despite growing revenue.
Square said sales rose 54% last year to $850.2 million and are on a pace to exceed $1 billion this year.
But Square’s net loss in 2014 grew at nearly the same rate, widening to $154.1 million from $104.5 million the year before.
Square also will have to assuage investor concerns about Mr. Dorsey. Earlier this month, the 38-year-old was appointed permanent chief of social-media company Twitter, of which he was also a founder and helped guide to an IPO in 2013.
The company said in its securities filing on Wednesday.
“This may at times adversely affect his ability to devote time, attention and effort to Square.”
It isn’t clear how much of any given day Mr. Dorsey spends at Square or Twitter offices, nor how his time on the IPO roadshow may affect Twitter’s operations.
More than being the face of the company, Mr. Dorsey is the largest shareholder, holding nearly one-quarter of Square’s stock.
Mr. Dorsey also profited by selling $1.2 million in marketing consulting services to Square through West Studios LLC, a private firm in which he holds a stake. West Studios also purchased 375,000 shares.
Including Mr. Dorsey’s stake, venture-capital firm Khosla Ventures’s 17.3% stake and smaller shares held by board members and executives, about two-thirds of Square is held by insiders.
A few company insiders—including co-founder James McKelvey,General Counsel Dana Wanger and director Larry Summers—cashed out of some of their shares in January 2014 at $13.53, according to the filing.
According to Square's S-1 filing, a total of 185,361,631 class B shares are held by outside investors, insiders and directors. The percentage of total class B shares held by major shareholders include Jack Dorsey (24.4%), Khosla Ventures (17.3%) and Director James McKelvey (9.4%).
Perhaps underscoring the risks Square’s investors see in the company, the company raised about $150 million last September and October in a round that came with potentially onerous restrictions.
Investors including J.P. Morgan Chase & Co. and Rizvi Traverse paid $15.46 a share and required that the IPO must price at $18.56 a share or higher, otherwise they are entitled to receive additional common shares, the filing shows.
Those firms will also get their money back before any other investor in the case of a company sale.
An $18.56 IPO price would suggest a pre-IPO valuation of $7.4 billion including stock awards, or $5.6 billion excluding them.
Square’s IPO, if successful, would cap a tumultuous six years for the payments company. As recently as last year, Square discussed with Alphabet Inc., then Google, a possible acquisition as its losses rose to around $100 million, people familiar with the matter told The Wall Street Journal at the time.
The company also backed off its e-commerce marketplace and mobile wallet, products it had touted as meaningful advances from its core card-swiping business.
The company typically charges merchants 2.75% to swipe credit cards through its reader, according to the company’s website.
The bulk of that money is spent on fees to payment networks, other financial intermediaries and fraud costs. And it faces competition from PayPal Holdings Inc., newly separated from eBay Inc., among other payment companies.
Square reported it was bilked by a single seller, costing it $5.7 million in this year’s first quarter, raising questions about its fraud-prevention systems.
Investors, too, may wonder how Square will replace lost revenue when its deal With Starbucks Corp. to process credit- and debit-card transactions in most of its stores concludes in next year’s third quarter.
That deal, while unprofitable, brought in $123 million in sales last year, or 14.5% of revenue.
Square said in its filing that it expected Starbucks to seek another payment processor and had given the Seattle company leeway to do so starting this month.
More recently the company has been focusing on peer-to-peer payments and small business lending to help boost its results. Square said it had originated $225 million in loans since May 2014.
COMMENTARY: Square has never generated a profit since it was founded. For the year ending December 31, 2014, Square had a net loss of $154 million. For the six months ending June 30, 2015, Square had a net loss of $77.6 million, so it appears to be on course to lose about as much money in the year 2015 as it did in 2014.
Gross Payment Volume (GPV)
- Processed $23.8 billion in payments in 2014, and on course to do $35-36 billion in 2015.
- Square processed 446 million individual payments from 144 million cards.
- Retail businesses make up 21% of Square’s merchants, followed by services at 17%, and food businesses at 15%.
- The tiniest sellers (processing less than $125,000 in payments per year) represented 92% of its merchants in the second quarter of 2011, compared with 63% in the same quarter this year— meaning that its stable of large customers has grown, relatively speaking
- Square’s deal to handle payments for Starbucks is a money loser. Square lost $28 million from the partnership in 2014, and $14.3 million in the first six months of 2015 (luckily for Square, the relationship will end by October 2016, if not earlier)
Square is a relative small fry when you compare the firms Gross Payment Volume (GPV) with the $4.9 trillion in total purchases paid by credit card as of 2013.
By comparison, Paypal, the gross payment volume (GPV) leader, processed $65.94 billion in credit card payments in the Q2 2015 alone and $248.23 billion in GPV during the 12 months up to and including Q2 2015. Paypal also generated net income of $419 million for the year ending December 31, 2014. When you compare Square's numbers, it's no contest.
Consolidated Statement of Operations
Quarterly Results of Operations
Consolidated Balance Sheets
Square has a pending patent infringement litigation with Robert E, Morley and a related entity and has yet to be settled. This should be of concern to potential IPO investors because it has serious consequences if the court rules against Square. Facebook was faced with three major lawsuits prior to its IPO, but these were all settled before the IPO date. The most famous lawsuit was filed by Cameron and Tyler Winklevoss, classmates of Mark Zuckerberg at Harvard. The Winklevoss twins claimed that Mark Zuckerberg had stolen the idea for Facebook from a social network that Zuckerberg had contracted to write the software for. This lawsuit was settled for a reported $100 million.
Here's what the IPO filing says about the Morley lawsuit on page 39.
"We are currently in litigation with Robert E. Morley and a related entity regarding the inventorship of certain patents related to our intellectual property (Morley Litigation). If one or more claims in the Morley Litigation were determined adversely to us, or if the Morley Litigation were settled on unfavorable terms, this could affect our ability to use certain intellectual property and could also result in substantial monetary liabilities. In addition, Mr. Morley filed a subsequent lawsuit containing allegations that the formation of Square and the development of our card reader and decoding technologies constituted, among other things, breach of an alleged oral joint venture, fraud, negligent misrepresentation, civil conspiracy, unjust enrichment, and misappropriation of trade secrets, as well as other related claims. Mr. Morley contends that he was an equal partner with Jack Dorsey and Jim McKelvey in the business enterprise that ultimately evolved into Square, and that Mr. Dorsey and Mr. McKelvey breached their alleged oral joint venture agreement with Mr. Morley by excluding him from ownership in Square. Mr. Morley is seeking a judgment and order that Square, Mr. Dorsey, and Mr. McKelvey hold ownership of Square in constructive trust for Mr. Morley, as well as a variety of damages, injunctive relief, royalties, and correction of inventorship of certain of our patents."
Square SEC Form S-1 (IPO Filing)
Below is the complete Square Inc SEC Form S-1 (IPO Filing).
I am always concerned when a startup that has never generated a profit since it began operations, that startup competes in a mature and highly competitive industry (credit card payments) and that industry is dominated by larger and more established players, and that startup is led by a CEO (Jack Dorsey) who splits time between two troubled companies (Twitter and Square), and then that CEO thinks its time for an intial public offering when stock market indicators say otherwise, then it makes me wonder about the wisdom of that CEO. This is the case with Square, Inc. and CEO Jack Dorsey.
Jack Dorsey has his work cut out for him, not only with Square, but especially with Twitter, a social network which has never generated a profit, has lost numerous executives since the start of this year, whose monthly active users has stalled, and advertisers are questioning Twitter's viability as an advertising platform.
Dorsey recently announced that Twitter would layoff about 10% of its workforce or about 336 employees, mostly from its engineering staff. This will cost the company about $20 million in severance payments and other separation entitlements. Even after you factor the savings from in wages, payroll taxes and employee benefits due to these layoffs, this will not make a substantial dent in their operating losses to date. This makes you wonder if Square will require some staff pruning after the IPO.
Even if you adjust Square's earnings for the money that it is losing from the Starbucks deal, the company is still losing a substantial amount of money. Unfortunately, Square will continue to lose money off the Starbucks deal until October 2016.
Lise Buyer, an IPO consultant with Class V Group in Silicon Valley who also helped guide Google Inc's IPO, said so eloquently, and dead on.
"Management and management focus are the single most determining factor of the success or lack thereof of a company pursuing an IPO. Were I a (Square) investor, I would want to be compensated for the cost of a part-time CEO who already had a full plate. And by compensated I mean I would expect a lower valuation."
David Erickson, a longtime banker and venture capitalist who teaches at the University of Pennsylvania Wharton School of Business, has real concerns about Jack Dorsey's ability to run two troubled companies simultaneously.
"Investors would have to get comfortable with how he would do both jobs well. What would also, I think, make this particular situation more challenging is the turnaround currently going on at Twitter, and the time I assume it would require."
Lisa Buyer, of Class V Group, echos similar concerns about turning round two companies simultaneously.
"There is so much uncertainty and so much attention needed at Twitter that it certainly should not inspire confidence in potential investors about Square.”
Let's come to some agreement here. Nothing significant is going to change at either Twitter or Square by the end of this year, or even within the next year. Twitter may never grow much beyond 300 million active users or increase engagement significantly without a major increase in new users. I am already juggling too much time between Facebook, Twitter and LinkedIn. I think most users are not going to abandon Facebook so they can tweet all day long. They simply have to much invested in Facebook and other social networks.
In conclusion, after reviewing Square's achievements and numbers, I am of the opinion that the Square IPO is just too high risk. There is none of the hype that existed when Facebook had their IPO. Facebook shares were selling in the secondary markets for over a year before their IPO, setting the market price, and raising expectations to intolerable levels. Square would need to add a dozen major accounts with the volume of a Starbucks, and those accounts would have to be profitable, between now and the actual IPO date to create investor excitement and hopes of a successful IPO. I don't see any evidence that Square is raising expectations and creating excitement among potential investors. In fact, the reverse is true -- there are a lot of doubts about the Square IPO.
In short, the Square IPO is DOA. It was a bad idea from the beginning, and only going to benefit early investors and a few of the employees. In fact, most of the early VC's have clauses that in the event of an IPO, they get their money first. Isn't capitalism great?!! Yippee Kiyeaa!!
Courtesy of an article dated October 14, 2015 appearing in The Wall Street Journal, an article dated October 15, 2015 appearing in MediaPost Mobile Marketing Daily, an article dated October 14, 2015 appearing in Fortune Magazine and the SEC Form S-1 Registration Statement filed by Square, Inc. 0n October 14, 2015