Square has registered to hold its IPO. The startup that allows small merchants to process credit cards with mobile devices wants to raise upward of $275 million, although that figure could change.
As part of the IPO process, Square's S-1 registration form and financial details are publicly available. A look through the documents shows a complicated picture in which digital-payment processing may not be enough by itself to bring the company to profitability.
Square is still losing money. Square has been in the red since at least 2012, which is the earliest year for which the company provided financial information. Losses increased by 76 percent through 2014. The first six months of 2015 show a slightly smaller loss than 2014, but only 7 percent ($74.4 million this year versus $79.9 million a year earlier). So, the chance of repeating the same loss as last year is strong, even though revenue is 50 percent higher.
Stock-based compensation is a big part of the loss. Providing shares of stock to management and key employees is a typical part of tech compensation and is counted as an expense. In 2014, the total was $36.1 million, which would have a significant impact on the net loss of $154.1 million. In the first six months of this year, stock compensation was $28.7 million, compared to $14.3 million in the first six months of 2014.
Starbucks' business has been a big sinkhole. In August 2012, Square and Starbucks announced a partnership in which people could pay for their grande lattes with their smartphones. Starbucks invested $25 million in Square, and its CEO, Howard Schultz, was on the Square board, but only for a year. Things didn't work out and the filing shows that the entire partnership was a money sink for Square. The transaction costs were always larger than the revenue haul, and from 2012 through the first six months of 2015, the Starbucks deal alone cost Square $67.5 million in losses. The parties aren't renewing the partnership, but it won't officially expire until the third quarter of 2016, though may end earlier. That's only good news for Square. In the first six months of 2015, gross profit would have been $198.8 million instead of $164.6 million.
Transaction costs are huge. Square isn't building the business just on processing payments because the margin on the service is low. In the first six months of 2015, the company kept only 36.5 percent of transaction revenue after its direct costs. Furthermore, transaction and advance losses -- chargebacks because of fraud or uncollectible transactions -- seem huge. In the first six months of this year they ran $24.8 million, or 15 percent of the $164.6 million gross profit (money left after deducting direct transaction, software, and hardware costs from total revenue). For comparison, in the second quarter of 2015 (first quarter reporting after the split from eBay), PayPal had $2.3 billion in net revenue, transaction expenses of $634 million, and transaction and loan losses of $185 million. It kept 64 percent.
Ultimately, Square may not be in the payment business. Reading the S-1 as a whole, Square plans on using what it learns about its clients to develop new services as a way to build the business. Given the high transaction costs and chargeback rates, that suggests processing payments is only the door into clients, not the strategic center of the company's business model. That means potential investors have to reassess what they think Square does and what it will take to eventually become profitable.
There is a two-class stock structure. The tech industry has become notorious for creating multi-tiered stock structures to leave founders in total control, no matter how many shares are sold to the public. Square has Class A and Class B shares, the latter shares having ten votes each and the former, only one. Such a structure can mean shareholders effectively have no voice whatsoever in what the company does.
The CEO is busy elsewhere. Jack Dorsey, CEO of Square, also became permanent CEO of Twitter this month. He will likely have to divide his time because the social network has some significant problems that will take attention to fix, if possible. That could distract Dorsey from doing what Square also needs.