Square/Afterpay: a clear challenger to big banks emerges

Square Inc updates

Using stock to fund an acquisition is a form of buy now, pay later. Square, the fintech of US entrepreneur Jack Dorsey, has announced it is spending $29bn of its shares on Afterpay. Consumers use the Australian app to purchase goods on credit repaid via monthly instalments. Afterpay shareholders will end up owning nearly a fifth of its acquirer.

Square has emerged as one of the big winners of the pandemic. Its share price has nearly tripled in the past two years thanks to a broader land grab in payments. New entrants with new technology are wresting market share from traditional banks, money agents and point-of-sale specialists. The expanded Square will lead the pack of challengers.

“Buy now, pay later” is the most hyped subsector of payments fintech. Here, Afterpay competes alongside rivals Klarna and Affirm. The brand names and networks of incumbents no longer provide the barriers to competition they once did.

Square is best known for its payments hardware systems for midsized retailers. But its Cash App for consumers has quickly gained traction allowing users to move money, buy stocks and cryptocurrencies and set up banking transactions. Square says it can integrate Afterpay into both its merchant and consumer segments, further advancing its own network effect.

In the year that ended in June, Afterpay generated $700m in revenue, implying a transaction multiple of more than 40 times. Square’s own market worth of $110bn approaches that of Citigroup. The dilution of issuing its shares is mitigated by the massive run-up in its stock price.

The dirty little secret of most financial services upstarts is that they are inextricably dependent on the banks they are trying to usurp. Credit fintechs such as Afterpay are one example. They rely on wholesale lenders for funds needed from wholesale lenders.

The real edge such fintechs can provide are better apps allowing them to connect with new generations that have little loyalty to the likes of JPMorgan Chase.

Square commands a valuation that would make little sense for a mature business — its price to estimated 2021 earnings is 150 times. This represents the belief among investors that Square can wrest an ever-growing chunk of payments from incumbents. The stronger that belief, the more valuable the equity Square can use to pursue that vision.

Lex recommends the FT’s Due Diligence newsletter, a curated briefing on the world of mergers and acquisitions. Click here to sign up.

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