Square IPO More about the Future than the Present Low Valuation

Square is set to go public with its shares priced at $9. For stakeholders the important questions is where shares

After Square filed its intentions to go public in October, investors were initially curious about the demand and valuation the payment startup would be able to command. Following its last funding round in 2014, the firm raised capital with a $6 billion valuation. However, the firm is slated to see its post-IPO value well below that mark after it priced shares at $9 and a valuation of around $2.9 billion.

More worrisome is that the $9 figure was well below the firm’s initial $11-$13 range it initially expected to receive earlier this month. The downward pricing reflects both a decline of investor appetite towards technology stocks in general, as well as potential worries about Square’s potential profitability.

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Not a Real $6 Billion Valuation

In terms of investors of Square’s latest funding round in 2014, the IPO value isn’t necessarily indicative of them holding a 50% loss on their investment. Like market capitalization figures for public companies, Square’s $6 billion valuation was based on total shares times a stock price. However, unlike public firms, also included were unexercised options, with these shares never becoming relevant due to the decline in Square’s stock price from above $15 in 2014 to the current $9.

More importantly, as revealed in Square’s IPO prospectus, many investors of the firm’s previous funding round were provided guaranteed returns of 20%. As a result of the drop off in the share’s price, these investors are being granted additional shares to boost their overall ownership, but dilute others.

Future

Of more immediate concern for Square though than its IPO valuation is maintaining revenue growth and achieving profitability. The firm reported top line revenue growth of just above 50% for 2014 compared to 2013, with H1 2015 results also showing an increase of 50% in revenues compared to the same period last year. However, the firm has yet to achieve a net profit on its operations but was near doing so for H1 2015 when backing out losses from its partnership with Starbucks which is being discontinued.

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For employee shareholders and many investors, even at a $2.9 billion valuation, their holdings are seeing a considerable return. But, with the lockup period ending after six months following Square going public, the ability to cash out on those shares will only occur in the future. The result is that for the majority of stakeholders, the next six months is an important period for the firm to produce successful results.

Square’s IPO is emerging during a promising period for payment hardware providers

Operationally, Square’s IPO is emerging during a promising period for payment hardware providers. Despite being known for its square mobile point of sale (mPOS) device which enabled any smartphone or tablet to accept card payments, the firm has expanded to other areas of payment hardware. Square then registers ongoing revenues from its hardware customers from small fees charged on transactions using its devices. For Square, these fees compose the vast majority of the revenues.

One important trend in Square’s favor is the upgrading by merchants of their POS terminals in the US from magnetic swipe readers to devices with pin-codes for cards with chips and NFC technology for smartphones. The main impetus for the upgrades was spearheaded by global card networks, including Visa and Mastercard, to push responsibility of fraud from magnetic strip-based purchases to merchants. For Square and other hardware providers, this has created the opportunity for a large upgrade cycle to take place.

Nonetheless, Square also faces numerous competitors. Namely, the mPOS space in the US is expected to become more crowded due to European firms such as SumUp arriving stateside as well as from domestic startups. In its prospectus, Square noted that they could also see competition from competitors that can undercut prices on POS devices to cross-sell other payment related services.

With customers rarely switching payment providers, even with the competition Square should be able to maintain its current revenue levels. But, investors will ultimately be focusing on continued growth which will determine the firm’s future and more important, valuation.

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