USA TODAY International Edition
Square’s IPO filing raises several flags
Use of an innovative metric is reminiscent of Groupon in 2011
As Square executives hit the road this week to help investment bankers sell the start- up’s pending stock sale, the financial technology firm’s IPO securities filing is asking investors to consider an innovative financial metric.
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 multiyear predictor of any company’s sales growth prospects, not a one- off that boosted growth and whose end will distort future year- overyear 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.
Square’s filing shows that leaving out those costs, by considering “adjusted revenue” vs. 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 past 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 nine 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 its S- 1 filing, is leaving out similar costs, not onetime items but recurring charges worth more than half its revenue, when it touts this metric in its filing. Yellow flag! This column can’t stress enough to readers the difference in the IPO filings of Facebook and Twitter on the one hand and Groupon, Zynga, Twitter and now Square on the other.
Facebook and LinkedIn 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: 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 vs. 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 overestimated the value of several high- profile tech start- ups.