Square is paying more for growth every year
SAN FRANCISCO — As Square prepared to announce pricing for its pending stock sale late Wednesday, the financial technology firm is asking investors to consider an innovative financial metric, according to its IPO filing.
Square, led by CEO Jack Dorsey, calls the measure "adjusted revenue," and by including it, is asserting that it’s worth considering when evaluating its IPO shares.
Given that the measure excludes revenue and costs from the company's partnership with Starbucks, which ends next year, that makes sense on the surface.
Investors want a multi-year predictor of any company’s sales growth prospects, not a one-off that boosted growth and whose end will distort future year-over-year comparisons.
Yet Square’s new metric also excludes one of the company's largest recurring costs, namely the transaction fees it pays when businesses use its service to take payments from customers.
Leaving out those costs, by considering “adjusted revenue” versus the time-tested and more reliable measure of net revenue, masks a bearish trend.
Such costs have become a larger percentage of Square’s revenue during the last three years.
In 2013, transaction costs were 50% of Square's annual net revenue, better known simply as revenue.
Last year that ratio crept up to 53%, and for the first 9 months of this year, the expense equaled 58% of Square's revenue.
That helps explain why the company's losses have been piling up, and why it may go public at a valuation lower than the one it earned in its last private funding round.
The use of a non-GAAP metric so prominently in Square’s filing recalls early attempts by Groupon, in the months before its offering in November 2011, to use a similar metric.
Groupon’s measure, which the SEC later forced the company to move below talk of net revenue in its filing, left out payments it made to acquire email addresses.
That was a major component and cost of the marketing strategy for the daily deals company.
Square, in touting this measure in its S-1 filing, is leaving out not one-time charges but recurring expenses worth more than half its revenue.
Yellow flag!
This column can’t stress enough to readers the difference in the IPO filings of Facebook and LinkedIn on the one hand and Groupon GRPN, Zynga ZNGA, Twitter TWTR and now Square on the other.
Facebook FB and LinkedIn LNKD were largely profitable on a quarterly basis — as measured by the good old standard of net income, rather than cash flow — and had multiple profitable quarters at the time they went public.
They have rewarded their IPO investors handsomely, and retail investors could have gotten Facebook at half-price by waiting four months in 2012.
Groupon, Zynga, Twitter and now Square neither had nor have any such financial history at the time of their respective IPO filings.
The first two were disastrous IPOs for retail investors, while Twitter has lagged the returns of the Nasdaq two years after its IPO.
Square has one other innovation that’s unusual.
It was included in Square’s last (private) funding round, and it was a promise of a guaranteed return to investors.
Yes, that’s right: Jack Dorsey’s company, Square, which has never earned a quarterly profit, gave his private investors a guaranteed return of 20%, according to its securities filing.
If needed to cover that financial covenant, the trigger will dilute ordinary shareholders by selling up to 14% more shares, or 31 million versus the current 27 million, in a follow-on offering.
Big red flag!
The public markets look set to signal again, via the Square IPO, that late-stage investors in private U.S. markets over-estimated the value of several high-profile tech startups.
John Shinal has covered tech and financial markets for more than 15 years at Bloomberg, BusinessWeek,The San Francisco Chronicle, Dow Jones MarketWatch, Wall Street Journal Digital Network and others. Follow him on Twitter: @johnshinal.