Many investors first think of Square (SQ) as a POS (point-of-sale) system for small brick-and-mortar merchants, and I don't blame them. Square solutions are easy to identify in our day-to-day lives, with their contact-less chip readers and quick-checkout tools. "Sidecar payments" were the primary source of gross profit for the company back in 2016.
Today, software solutions (back office, online selling) and integrated payments are the main drivers of the seller business. Square Capital (quick business loans) and Square Card (free business debit card) are also having a growing impact on the business.
Square's seller ecosystem is heavily reliant on SMBs. And the COVID-19 pandemic has prompted many analysts to raise the alarm and point to a potentially very challenging year for Square with many small businesses seeing their activity and transactions dry up.
But the fastest-growing segment in Square's gross profit is one that targets an entirely different ecosystem: individuals. The product behind this growth is a platform called Cash App.
Square launched its Cash App service in 2013. At the time, the focus was to compete with services like Venmo (owned by PayPal (PYPL)), Apple (AAPL) Pay, and Google (GOOG) (GOOGL) Pay.
At first, Cash App was just a P2P (peer-to-peer) payment service. Today, the platform has evolved into an all-in-one digital wallet combining a free debit card, cashback offerings, direct deposits, and now stocks and bitcoin investing.
The Cash App ecosystem is often overlooked by investors focused on the seller ecosystem. But I believe it's about to become the main catalyst for future growth, and it could be the platform that will help turn Square into a much bigger company in the coming decade.
Let's review why.
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Don't take it from me, but from the reputable research firm ARK Investment Management.
Cash App is closing in on Venmo and could come ahead at some point in 2020.
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This is also evident based on Google Trends, as reflected below. Cash App is now well ahead of Venmo in searches, and it has been the case for months.
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The most recent ranking released by Sensor Tower also shows Cash App as the fourth most downloaded fintech app in the world (up one rank from January to February). Cash App is in very good company between PayPal and Alipay (Note: PhonePe is an Indian e-commerce payment system and digital wallet company) .
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Let put Cash App in context with Square's FY19 numbers.
Square has seen impressive growth since going public in 2015.
Data by YCharts
If we look at the breakdown from management in their most recent investor update, Cash App was 25% of Square's gross margin in FY19. That compares with 6% in 2017 and less than 1% in 2016.
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And the momentum is accelerating. Square disclosed that Cash App was 27% of the company's gross profit in the most recent quarter ($144 million).
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Based on the trend over the past three years and the recent momentum, it's only a matter of time before Cash App becomes the dominant source of gross profit for the company.
Square has broken down its total addressable market as follows:
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The implication is that the runway ahead is larger for Cash App given that its run rate of $1.1 billion revenue in FY19 implies less than 2% market penetration.
Management is breaking down this $60B+ opportunity into three categories:
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And Cash App's market opportunity doesn't stop here. Over time, new products and use cases are likely to emerge. Cash App could become an all-in-one solution, targeting new areas such as lending or wealth management.
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Cash App is making money on all three categories it targets:
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Cash App really shines when it comes down to the variety of its revenue streams. The additional use cases developed since 2016 have created new avenues for growth that have stacked on top of the existing ones.
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To get a sense of the user base, what we usually refer to as MAU (Monthly Average Users) on social media platforms is referred to as MTA (Monthly Transacting Actives) for Cash App. It is defined by Square as "a Cash App customer who has one cash inflow or outflow during a given monthly period."
The number of MTA has gone parabolic for Cash App, from 3 million in 2016 to 24 million in 2019.
To measure a user base, a monthly metric is obviously much more valuable than a yearly one. When PayPal revealed that Venmo had 40 million active users in 2019, that number included 12 months of transactions.
What is even more interesting than the active user base of Cash App is how user engagement has grown just as fast.
The number of DTA (daily equivalent of MTA) has grown 80% Y/Y in Q4 FY19, which is even faster than the MTA. The implication is that not only are more users using the app, but they are doing so more frequently.
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Cash App has obviously proven that it could find and grow an audience very fast. Now, volume matters only if the unit economics are promising. And, in my view, this is where Cash App shines the most.
Revenue per customer has reached $30 annualized revenue per monthly active customer in 2019, a double from 2017 level.
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It gets more interesting when we analyse specific cohorts of users. Management gave shareholders a unique look into how fast they can recoup their user acquisition spend, using the example of the June 2017 cohort:
This means a return on investment of more than 5x after 2.5 years. And this cohort is obviously going to continue to generate revenue.
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The implication for such a strong return on investment shows in the financials of the company. Yearly gross profit by cohort has been expanding and cohorts of users are stacking. This is the true engine behind Cash App's meteoric rise.
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Not only is Square increasing its ARPU, but also its conversion rate. According to management, 50% of Cash App's quarterly users generated revenue in Q4 FY19. The high engagement within the ecosystem is what's driving the lifetime value per user higher.
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Consumers are willing to pay for convenience more than ever before. We increasingly expect everything to be handed over to us in a way that is simple, frictionless and all-in-one place. Be it for shopping, delivery, travel or entertainment, this has naturally contributed to the rise of digital wallets.
Cash App screenshot from Google Play store (Source).
With innovations like Cash Boost (instant cashback offer with specific brands) and Cash Card, Square has rewarded stronger engagement within its ecosystem.
At the end of the day, the Cash App Ecosystem is meant to replace the need for a bank account. The long game is not to take market shares from Venmo, but to gain shares from the entire banking and wealth management industry.
Last month, the FDIC (Federal Deposit Insurance Corporation) granted Square conditional approval to open a bank. Named Square Financial Services, the bank will open next year and will offer small business loans. There will be natural synergies and complementary features that could overlap between the seller and the Cash App ecosystem.
Another obvious area for future growth is the expansion beyond the US. Cash App is still a US-focused product. But Square has proven with its seller ecosystem that it can expand beyond North America when the time comes.
Square is likely to continue to scale user acquisition, and in return create organic growth via word-of-mouth as the existing community grows. With new users coming on the platform adding fuel to the fire, the existing very strong unit economics will continue to drive Cash App's importance in Square's gross profit expansion.
Source
Beyond what we know today, what remains the most exciting feature of Cash App is its optionality.
Acquisition, retention and monetization could expand even more over time with new use cases. Given how engaged existing users are, it's easy to see how future features could find success and further expand conversion and ARPU.
Lending and personal finance are obvious areas that Cash App is likely to target over time, and I can't wait to see more.
If you are looking for a portfolio of actionable ideas like this one, please consider joining the App Economy Portoflio. Start your free trial today!
The rise of the App Economy is disrupting many industries: retail, entertainment, financials, media, social platforms, healthcare, enterprise software and more.
While keeping in mind some of the best recommendations from experienced gurus of Wall Street such as Warren Buffett, Peter Lynch, Burton Malkiel or Philip Fisher, I am trying to beat the S&P 500 index by a significant margin.
Here are some of the trends reflected in the portfolio:
Disclosure: I am/we are long SQ AAPL GOOG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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Why Cash App Can Drive Square's Valuation Much Higher - Seeking Alpha
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