Back to Square One: Start-up Contemplating Sell-Off

Despite high-profile financial backing, generous media coverage and a growing customer base, innovative payments provider Square is learning the hard way what traditional third-party providers have known for years: payments is an incredibly competitive and unforgiving industry.

Following a year of big losses, Square is in talks with several of its rivals about potentially selling off its business, the Wall Street Journal reported.
 
People familiar with the situation informed WSJ that Google has been in discussions with Square about a possible acquisition since 2012. It is unknown whether those talks are continuing, though a Square spokesman said that the company has never been in acquisition talks with Google.

A deal with Google makes sense, noted Rick Oglesby, senior analyst and consultant for Double Diamond Payments Research. The Google Wallet has managed to sign up a lot of consumers through its app store, but has few brick-and-mortar merchants, Oglesby told the Journal. Square would present the Internet juggernaut with those a strong merchant component.

Square has also reportedly had informal discussions with Apple and PayPal, though those conversations never developed into serious talks. A PayPal spokesman told the Journal that the company had no acquisition talks with Square.

WSJ noted that Square experienced a loss of about US$100m in 2013, larger than its loss in 2012. The mobile payments start-up has used up more than half of the US$340m it has raised from four rounds of equity financing.

Founded by Twitter co-founder Jack Dorsey in 2009, Square is valued at roughly US$5.2bn. Nearly one million merchants use Square’s card-reading devices to take payments. In 2013, the company processed more than US$20bn in transactions, yielding revenue of about US$550m.

Nevertheless, the Journal noted that Square’s business yields ‘razor-thin’ profit margins, if any at all. The start-up typically charges retailers 2.75% per card transaction, and about 80% of that money goes to payment networks, other financial intermediaries and fraud costs. WSJ learned that Square’s gross margin – the portion of revenue remaining after paying processors and covering other costs – fell to 21% in 2013, down from 27% in 2012.

A Square executive reportedly told a potential acquirer in first quarter 2014 that the start-up only had nine months before it hit a ‘cushion’of funds set aside as a last resort.

One thing that has been hurting Square has been its partnership with coffee chain Starbucks, which began in 2012. Despite giving the start-up billions of dollars in new transactions, Square’s fee on those transactions was a little more than 2% last year – less than the average fee it charges other merchants. As a result, Square lost at least US$20m in 2013 from the Starbucks deal.

Square spoke with Goldman Sachs and Morgan Stanley about a possible initial public offering (IPO) late last year, although those discussions were – at least temporarily – suspended.

 

A payments processor who wished to remain anonymous told gtnews that the latest news about Square is likely to cause a huge collective cry of “We told you so” from the merchant acquiring community. He noted that when Square first started up, many veterans in the merchant-acquiring arena predicted that the company would get hammered with merchant-fraud losses. “However, now it appears that the real problem may be a simplified fee structure that, while being its main appeal to merchants, might also be its primary weakness,” he said. “But this probably won’t be the case for long, because fees are easy to change.”

The processor does not believe the losses that Square is incurring will ultimately spell its demise.  “They have adroitly adjusted to the requirements of scaling-up at each juncture, and I’m confident they can pivot again; even if it means raising fees,” he said. “Small merchants love Square and are likely to remain loyal, because of the value it provides to merchants goes beyond the costs.”

Anand Goel, CEO of Optimized Payments Consulting, told gtnews that for Square to be profitable, it needs to double its gross margin. He believes Square can accomplish this by increasing fees and stopping money-losing programs. “The Starbucks deal was strategic by getting a large brand to use the Square solution and getting investment from Starbucks,” he said. “However, the pricing offered to Starbucks was money-losing from the get go—how did Square ever think it could recoup the losses?”

Square knows plenty about money-losing programs, as evidenced by a US$275 monthly flat fee program it axed last year. “This program offered merchants a flat fee for processing up to US$20,000 in card sales per month,” Goel said. “It reduced the effective rate down to 1.32 percent for savvy merchants who processed up to US$20,000 per month while Square’s processing continued to be around 1.90 percent. Smartly, Square discontinued this program in November 2013.”

Goel believes that Square could also return to profitability by finding new sources of revenue. “Since Square proclaims to be a commerce company and not a payments company, it needs diversified revenue from sources like advertising to loyalty programs to customer acquisition,” he said.

Goel added that Square serves micro-to-small merchants—a niche segment that is not typically served by processors/ISOs. “When processors/ISOs do serve micro merchant and traditional small merchants, the pricing tends to be egregiously high and the merchant experience egregiously poor,” he said. “If anyone buys Square, it’ll be a company who can create new revenue streams and monetize some of the value Square provides its customers.”

5 views

Related reading

hanjin-shipping
donald-trump
job
New consumer banking head for Citi Asia Pacific