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When the money comes slowly, you still aggressively invest - Block "awkward"

On the evening of August 4th Beijing time, Block (SQ.US), a digital payment company, released its Q2 financial report for 2022 after the US stock market closed. Overall, the company's financial performance was basically as expected, lacking standout highlights to attract attention. The details of the financial report are as follows:

  1. Performance is worse than expected: This quarter, the company achieved total revenue of RMB 4.4 billion, a YoY decrease of 6%, mainly due to the significant drop in transaction volume caused by the sharp decline in Bitcoin prices. Excluding Bitcoin business, core revenue was RMB 2.62 billion, which was in line with market expectations but with a significantly slower YoY growth rate of 34%. In terms of profitability, due to the rapid growth of operating expenses, the company recorded a net loss of $210 million for the quarter, slightly higher than the market's expected loss of $204 million. Overall, the actual performance was basically consistent with expectations, but the slowdown in revenue growth and the shift from profit to loss could not be considered good.

  2. Square merchant business--steady increase in the proportion of medium and large merchants, but payment fees decrease: Square's revenue was RMB 1.73 billion, which was completely in line with expectations, but the financial data was also unimpressive. However, the proportion of GPV contributed by medium and large merchants increased significantly from 35% in the previous quarter to 39%, making it the merchant type that contributes the most. This indicates that the company's strategy of breaking through in merchant scale is steadily advancing. Dolphin Analyst believes that in the context of a declining US economy, low-income groups and small and micro merchants will be more severely affected, while medium and large merchants with higher risk resistance will be the stabilizer of the company's future revenue.

However, perhaps due to the increase in the proportion of medium and large merchants, the payment fee rate of the company's payment business continued to decline, resulting in a narrowing of the gross profit margin of the payment business.

  1. Cash App personal business--growth slowdown but increased stickiness: Excluding Bitcoin business, Cash App's revenue and gross profit for this quarter are also basically in line with market expectations. Without considering the impact of Afterpay's consolidation, revenue growth rate also slowed from 26% to 21%. The gross profit margin did not increase as expected by the market, but remained stable compared to the previous quarter. In terms of operational performance, Cash App's new download volume in this quarter decreased significantly, falling back to the level of Q2 last year. However, the frequency of use by existing users and user stickiness (DAU/MAU ratio) steadily increased. After experiencing a period of high growth, Cash App may have entered a period of consolidation.

  2. Expanding expenses, turning from profit to loss: In terms of gross profit, Cash App remained stable compared to the previous quarter, while Square business's gross profit margin slightly decreased due to the decline in payment fee rates. Therefore, the company's gross profit increased by 29% YoY, which was lower than the revenue growth after excluding Bitcoin business.

As the company is in a period of investment in multiple new businesses, total operating expenses have increased by 66% YoY, with research and development expenses related to development growing rapidly. Due to the mismatch between the investment pace and the slowdown in revenue growth, the company has shifted from being able to maintain stable profitability to a loss.

5.7 Monthly Operation Data Guide: The company does not give 3Q performance guidance, but shares July's operating data. Among them, it is expected that Square GPV will increase by 18% year-on-year, and the growth rate will further slow down compared with the 23% increase in the 2Q quarter. The gross profit of Cash App will increase year-on-year (without indicating the growth rate), and it can be inferred that the growth of Cash App and other businesses may not be satisfactory.

In terms of expenses, the company guides that the total Non-GAAP operating expenses for 3Q will increase by RMB 75 million on a month-on-month basis, and the equity incentive expenses will also increase slightly month-on-month. Therefore, the performance of the profit and loss statement in the third quarter may be even worse.

Dolphin Analyst's viewpoint: Overall, Block's financial report for this quarter is basically in line with market expectations, and there are not many differences worth paying attention to. However, as American residents (especially low-income groups) began to experience a decline in actual income and consumption after the prosperity during the epidemic, Block, which mainly serves small and medium businesses and low-income groups, has also entered a stage of slowing growth.

At the same time, although the company is steadily pushing forward the development of large merchants, integrating Afterpay and other new businesses, it has also resulted in mismatched growth in expenses and a significant deterioration in the company's overall profitability. This puts the company in an awkward stage of slowing growth of existing businesses, short-term ineffective new businesses, and greatly deteriorated profitability.

Dolphin Analyst will subsequently share the summary of the telephone conference with Longbridge App and Dolphin users. Interested users are welcome to add the WeChat account "dolphinR123" to join the Dolphin investment research group and get the summary of the telephone conference as soon as possible.

I. What You Need to Know About Block

Although Block is not large in scale, its business composition is quite complex. Therefore, readers who are not familiar with it can briefly understand the company's business composition through the table below to better understand Block's financial reports and our analysis.

Briefly speaking, the company's core business consists of two major segments: the Square ecosystem for merchants and the personal business centered on the Cash App e-wallet. Specifically:

1. Square Business provides merchants with POS hardware and payment settlement services and foundations, and extends to merchant business loan services (Square Loan) and ERP/CRM software services for merchant management.

2. Cash App business is based on free P2P transfer services between individuals, and extends to C2B payments (Cash for Business or Cash App Pay), co-branded card services, installment shopping services (Afterpay), stock investment (commission-free), and bitcoin transactions. 2. Square Business

First of all, the total revenue of Square Business reached USD 1.73 billion this quarter, which is basically in line with market expectations. However, the revenue growth rate of Square, excluding the contribution of Afterpay, was 24%, slowing down from 35% in the previous quarter, but still within expectations.

  1. The largest contributor to revenue is transaction fees, which generated USD 1.36 billion in revenue this quarter, a year-on-year increase of 22%, but slower than the 29% growth rate in the previous quarter.
  2. Excluding the impact of Afterpay's consolidation, subscription service revenue was USD 214 million, a year-on-year growth rate of 41%. However, the actual revenue has been declining for three consecutive quarters, and the growth momentum has slowed down.
  3. Hardware revenue was USD 48 million, with a growth rate of only 10%.

In terms of operating data, the payment amount (GPV) completed by Square Merchants was USD 48 billion, a year-on-year increase of 24%. Added with the C2B payment amount completed through Cash App, the total GPV was USD 52 billion, slightly lower than the market's expected USD 53 billion. Dolphin Analyst believes that the main reason for the lower-than-expected results is the significant slowdown in B2C GPV growth through Cash App.

As the revenue growth rate of Square's payment processing fees is lower than the GPV growth rate, it can be inferred that the processing fee rate has decreased. Longbridge's Dolphin Analyst estimates that the average processing fee rate for the payment business this quarter continued to decline to 2.81%, which is in a continuous downward trend. However, this is in line with the analysis of Dolphin Analyst before, that is, as the services provided by the company continue to grow for medium and large merchants, payment processing fee rates will continue to decrease.

以上为财报详细点评。 However, the growth of medium to large merchants is not a bad thing for the company, but rather one of the company's key strategies. Medium to large merchants can significantly drive GPV growth with fewer merchants, which should also increase usage rates for the company's other subscription services.

According to disclosures, the contribution of GPV from medium to large merchants with annual sales of $500,000 or more increased significantly from 35% in the previous quarter to 39% this quarter, indicating rapid growth consistent with the analysis above.

Regarding the company's vigorously developing merchant operating loan business, the amount of new loans issued by the company in the quarter was $1 billion, with growth slowing down, but still rapidly expanding at a rate of 60%. As a financial loan-based business, it is the company's second pillar business in the future and is also steadily growing.

Overall, the revenue performance of Square's merchant business in this quarter is generally in line with expectations. Against the backdrop of the U.S. stock market's economic downturn and weak consumer spending, residents (especially lower-income groups) are reducing their spending, so Square's business growth, which mainly serves small and medium-sized merchants, is also slowing down as expected. In contrast, the resilience of high-income groups and medium to large merchants is relatively better, which also helps the company's good strategic advances towards medium to large merchants.

2. Cash App personal business

After excluding the Bitcoin trading business, Cash App's consumer-oriented segment achieved revenue of $836 million this quarter, slightly higher than the market's expected $826 million. After excluding the impact of Afterpay, the comparable revenue growth rate was 21%, which was slower than last quarter's 26%. Specifically:

  1. Handing fee income based on C2B payments within Cash App was $116 million, up 5% YoY. The corresponding Cash App GPV this quarter is $4.2 billion, up only 4% YoY. In this regard, the Dolphin Analyst's view is that the habit of American residents to pay with bank cards is deeply ingrained, so it's not easy for mobile wallets to replace this habit, but it also makes sense to continue promoting Cash App's C2B payment business.
  2. Subscription and service revenue mainly based on co-branded debit card business and instant withdrawal business (to bank accounts) was $616 million this quarter, up 24% YoY, which did not slow down significantly compared to the previous quarter's growth of 28%. Earlier this year, Block increased the upper limit of the service fee rate for users to withdraw instantly from 1.5% to 1.75% and set a minimum charge of $0.25 per transaction. At the same time, PayPal's mobile wallet, Venmo, also raised its instant withdrawal rate from 1.5% to 1.75%. Therefore, the main reason for the strong revenue growth may be the increase in instant cash withdrawal fees.

Although the company has not yet disclosed official monthly active user data on operating data, third-party research data can also give us a glimpse into Cash App's user growth. According to SensorTower statistics, in the second quarter of this year, Cash App's downloads have significantly fallen to the same level as the second quarter of last year, after experiencing a surge from the end of 2021 to the beginning of 2022. It can be seen that in the case of a deteriorating macroeconomic situation, Cash App's user growth should also have slowed.

However, some users have steadily increased their frequency and duration of using Cash App, as well as their user stickiness (daily active users accounted for the proportion of monthly active users).

III. Bitcoin and Other Businesses

This quarter, Bitcoin business revenue was USD 1.786 billion, a slight increase from the previous quarter, better than market expectations of USD 1.696 billion. Dolphin Analyst believes that this is mainly because the Bitcoin price has stabilized after a sharp decline and rebounded slightly, and the trading heat of cryptocurrency is better than pessimistic expectations.

This quarter, Afterpay realized revenue of RMB 20.8 billion, a significant increase from the previous quarter's revenue of RMB 13 billion. This is mainly because in the previous quarter, the company was relatively cautious in the development of Afterpay when it was combined, almost suspending the approval of new users, and the integration with the company's Square and Cash App is still in its early stage.

The significant growth in revenue this quarter indicates that the integration of Afterpay with the company is gradually improving, and the interaction effects between Afterpay and the company's existing businesses are worth looking forward to.

Other emerging businesses mainly based on Tidal, Spiral, and TBD, achieved revenue of RMB 57 million this quarter, which is basically the same as the revenue of the previous few quarters. It can be seen that emerging businesses are still in the experimental stage and have little impact.

IV. Overall Revenue and Gross Profit

  1. Adding up the above businesses, the company's total revenue this quarter was USD 4.4 billion, a year-on-year decrease of 5.9%, but slightly higher than market expectations of USD 4.34 billion, mainly due to the better-than-expected performance of Bitcoin business. After excluding the highly volatile Bitcoin business, the company's revenue was RMB 2.62 billion, and the comparable revenue growth rate was 34%, which was slightly lower than the expected USD 2.65 billion.

  2. From the perspective of gross profit, the gross profit for the quarter was US$1.47 billion, in line with market expectations, a year-on-year increase of 29%. The gross profit margin also increased from 32.7% in the previous quarter to 33.4%. Specifically, although the gross profit margins of each segment did not improve, the overall gross profit margin increased from 32.7% to 33.4% quarter-on-quarter due to the decrease in the proportion of revenue from the bitcoin business, which had very low gross profit.

Specifically:

  1. The Square segment achieved a gross profit of 755 million yuan, slightly higher than the market's expected 740 million yuan. After deducting the contribution of Afterpay, the comparable gross profit increased by 16% year-on-year. The gross profit margin also decreased from 45.8% to 43.8% quarter-on-quarter. The Dolphin Analyst believes that the main reason for the decrease in gross profit margin is due to the decrease in payment processing fees.
  2. After excluding the bitcoin business, the Cash App segment achieved a gross profit of 663 million yuan, in line with market expectations. However, since the revenue slightly exceeded expectations this quarter, the gross profit margin of the segment did not actually improve as expected by the market. Specifically, the gross profit margin of Cash App (ex. BTC) this quarter was 79.3%, the same as the previous quarter, while the market expected it to be 80%.
  3. Although the revenue scale of the bitcoin business is huge, the gross profit is very low. The gross profit for the quarter was US$41 million, which is similar to the gross profit of the previous quarters, but exceeded the market's pessimistic expectations of US$16 million.

IV. Expenses and Profits

Due to the large fluctuations in the company's total revenue caused by the bitcoin business, the proportion of expenses to income has little reference significance. Therefore, we mainly observe the growth of expenses. Overall, the total revenue (ex. BTC) increased by 34% year-on-year, gross profit increased by 29% year-on-year, and total operating expenses were 1.683 billion yuan, which is basically in line with market expectations and guidance. The company is still in the stage of expanding its business, and expenses are still expanding significantly, increasing by 66% year-on-year.

Specifically, the absolute value of administrative expenses decreased compared to the previous quarter (possibly mainly due to the reduction in share-based compensation expenses). However, due to the company's merger with Afterpay and its investment in other new businesses, the growth rate of research and development expenses increased from 56% to 61% quarter-on-quarter. In the context of a weakening macro environment and a slowdown in the company's growth, the growth rate of marketing expenses also further slowed down. In addition, the company's bad debt losses this quarter reached 157 million yuan, an increase of 72% compared to the previous quarter. This shows that bad debt risks have increased significantly as the US stock market economy enters recession.

Therefore, against the backdrop of operating expenses growing significantly faster than revenue and gross profit growth, the company recorded a net loss of US $214 million this quarter. Excluding equity incentives and other adjustments, the Non-GAAP operating profit calculated by Dolphin Analyst was 79 million yuan, further narrowing from 125 million yuan in the previous quarter.

Overall, Block has also entered a vicious circle of mismatch between investment pace and revenue growth. The revenue growth rate has slowed significantly under the influence of the macro environment, but the company has not hesitated to invest heavily in new businesses, leading to stable profitability in 2020 and the first half of 2021, but a significant loss in 2022.

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Previous research:

Deep Dive

July 19, 2022 "Bubble of Square Needs to be Popped Despite Its Drive"

June 21, 2022 "Trillion-dollar Choice for Payment: Who will Triumph between Square and PayPal"

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