Sector

PaymentsFinancial Services

Background

Hamish Corlett is an investor at TDM Growth Partners. We cover the common threads that have enabled Block to organically build two major ecosystems in Square and Cash App, how the recent Afterpay acquisition can strengthen the connective tissue between those businesses, and the competitive frontiers Block faces.

Cover

Date

April 6, 2022

Episode Number

53

Block Business Breakdown

Background / Overview

Block, formerly Square, was founded in 2009 by Jack Dorsey and Jim McKelvey in St. Louis, Missouri, with a mission centered on economic access and empowerment. Initially launched as a simple card reader to enable micro-merchants to accept card payments, Block has evolved into a $75 billion market cap financial services and software company, comparable in scale to Citigroup. The company operates six distinct businesses: Square, Cash App, Afterpay, TIDAL, Spiral, and TBD, serving merchants, consumers, developers, and artists. With over 40 products combining hardware, software, and financial services, Block has achieved a gross profit growth from $500 million in 2015 to over $5 billion, reflecting a ~50% CAGR, primarily through organic growth.

Ownership / Fundraising / Recent Valuation

Block went public in late 2015 and currently has a market capitalization of approximately $75 billion. The company has pursued strategic acquisitions, notably Afterpay in 2021 via an all-stock deal, issuing ~25% of its capital. Smaller acquisitions, such as TIDAL and Weebly, were in the hundreds of millions. No specific enterprise value multiples or recent fundraising details were disclosed, but the Afterpay acquisition highlights Block’s focus on integrating complementary businesses to enhance its ecosystem.

Key Products / Services / Value Proposition

Block’s offerings span two primary ecosystems—Square (merchant-focused) and Cash App (consumer-focused)—with Afterpay bridging the two. Below is a breakdown of key products:

Value Proposition:

• Square: Simplifies payment acceptance and business management for merchants with seamless onboarding, integrated software, and financial tools, targeting underserved micro and small businesses.
• Cash App: Offers a frictionless, consumer-friendly financial suite for the unbanked/underbanked, with features like P2P transfers, debit cards, and Bitcoin trading.
• Afterpay: Drives merchant sales (20-30% increase in conversion and order value) and consumer flexibility through interest-free installment payments, fostering two-sided network effects.

Segments and Revenue Model

Block operates two primary segments:

1. Square Ecosystem (Merchant): Provides payment processing, integrated software, loans, and debit cards for 3M merchants, generating ~$2.8B in net revenue and ~$2.3B in gross profit. Revenue comes from transaction fees (3%, ~1% net take rate), software subscriptions, and loan servicing fees.
2. Cash App Ecosystem (Consumer): Serves 100M annual active users with P2P transfers, debit cards, instant deposits, and Bitcoin trading, contributing ~$2.7B to gross profit. Key revenue drivers include instant deposit fees (50% of gross profit), cash card interchange ($500M), and Bitcoin trading fees ($200M).

Afterpay acts as a connective layer, enhancing transaction volume and merchant discovery between ecosystems. TIDAL, Spiral, and TBD are smaller, mission-driven ventures with minimal current revenue impact.

Splits and Mix

• Geographic Mix: ~90% of Square merchants and most Cash App users are U.S.-based, with Afterpay adding exposure in Australia, the UK, and the EU.
• Customer Mix: Square targets micro to large merchants; Cash App serves consumers, particularly Gen Z and millennials, with ~60M unbanked/underbanked as a key demographic.
• Product Mix: Square’s gross profit is ~80% from payments and integrated software, with the rest from loans, cards, and transfers. Cash App’s gross profit is ~50% from instant deposits, ~30% from cash cards, ~10% from Bitcoin, and the rest from other services.
• Channel Mix: Square is strong in offline payments but has bolstered online capabilities via Weebly and Afterpay. Cash App is primarily app-based, with Afterpay enhancing online merchant discovery.
• End-Market Mix: Square serves diverse verticals (e.g., retail, hospitality); Cash App targets consumer financial services, with Afterpay focusing on retail and fashion.

Mix Shifts:

• Square has moved upmarket from micro to larger merchants while maintaining take rates, increasing gross profit per merchant.
• Cash App’s shift toward cash card adoption (30% penetration) and instant deposits has boosted higher-margin revenue streams.
• Afterpay’s integration is driving merchant discovery, potentially increasing transaction volumes and ecosystem GMV.

KPIs

• Square: ~3M merchants, ~$200B GMV, 18-month payback period, 3x ROI over three years, ~$2.3B gross profit.
• Cash App: ~100M annual active users, 12-month payback period, 6x ROI over three years, 125% net gross profit dollar retention, ~$2.7B gross profit.
• Afterpay: ~20M consumers, 100K merchants, ~1M daily leads, driving 20-30% merchant conversion uplift.
• Growth Trends: ~50% gross profit CAGR since 2015, with sustained user and merchant growth, though Cash App’s CAC rose from $5 to $10 recently due to aggressive marketing.

Headline Financials

• Revenue: ~$2.8B net revenue for Square; Cash App’s revenue is less clear but supports ~$2.7B gross profit. Total gross profit grew from $500M (2015) to ~$5B.
• EBITDA: Not explicitly disclosed, but Square’s blended gross margin (~82%) and Cash App’s high-margin services suggest strong EBITDA potential.
• FCF: Not disclosed, but low capital intensity (software-driven) and efficient CAC imply robust cash conversion, tempered by M&A and Bitcoin investments.

Long-Term Trends:

• Gross profit growth reflects scale economies and product layering, with margins improving as higher-value services (loans, cash cards) gain traction.
• Operating leverage is evident in low CAC (~$5-$10 for Cash App vs. hundreds for banks) and scalable technology.

Value Chain Position

Block operates midstream in the financial services value chain, between card networks (Visa, MasterCard) and end-users (merchants, consumers). Its primary activities include payment processing, software development, lending, and consumer financial services.

• Supply Chain: Relies on card networks for transaction clearing, third-party loan buyers for Square Loans, and technology infrastructure for software/app delivery.
• Go-to-Market (GTM): Square uses a direct-to-merchant model with viral hardware (card readers) and seamless onboarding. Cash App leverages app-based distribution, viral marketing (e.g., Cash App Fridays), and cultural branding. Afterpay enhances GTM via merchant partnerships and consumer discovery.
• Value-Add: Block’s competitive advantage lies in frictionless onboarding, data-driven services (e.g., loans, fraud detection), and integrated hardware/software, delivering superior customer experiences compared to legacy providers.

Customers and Suppliers

• Customers:
• Square: ~3M merchants, from micro to large, across retail, hospitality, and services, with ~90% U.S.-based.
• Cash App: ~100M annual active users, targeting Gen Z, millennials, and the unbanked/underbanked.
• Afterpay: ~20M consumers and 100K merchants, focused on retail and fashion.
• Suppliers: Card networks (Visa, MasterCard), third-party loan buyers, cloud infrastructure providers, and hardware manufacturers.

Pricing

• Square: ~3% transaction fee, ~1% net take rate after card network/issuer fees. Loans carry a 6% servicing fee; software subscriptions have typical SaaS pricing.
• Cash App: Free P2P transfers; instant deposit fees (not disclosed), 0.25%-3% cash card interchange, ~2% Bitcoin trading fee.
• Afterpay: ~2%+ merchant transaction fee, no consumer interest.
• Contract Structure: Short-term, transaction-based with high visibility due to recurring usage. No long-term lock-ins, fostering flexibility but requiring continuous engagement.
• Pricing Drivers: Block maintains pricing power through brand strength, differentiated services (e.g., instant onboarding, data-driven loans), and mission-criticality for merchants. Afterpay’s value lies in driving merchant sales, justifying fees.

Bottoms-Up Drivers

Revenue Model & Drivers

Block generates revenue through transaction fees, service fees, and software subscriptions across its ecosystems.

• Square:
• Revenue Model: ~3% transaction fee on ~$200B GMV, yielding ~$2.8B net revenue after ~1% net take rate. Additional revenue from loans (6% servicing fee), cards, and software.
• Price: Stable at ~3% despite upmarket shift, driven by value-added services (e.g., integrated software, loans).
• Volume: ~3M merchants, ~$200B GMV, growing via new merchants and higher transaction volumes.
• Drivers: Brand reputation, seamless onboarding, product bundling (e.g., loans, cards), and omnichannel expansion (Weebly, Afterpay).
• Cash App:
• Revenue Model: Instant deposit fees (50% of gross profit), cash card interchange ($500M), Bitcoin trading (~$200M), and minor contributions from other services.
• Price: Interchange (0.25%-3%) and Bitcoin fees (~2%) are market-driven; instant deposit fees are usage-based.
• Volume: ~100M users, with ~30M cash card holders, driven by viral marketing and network effects.
• Drivers: Cultural resonance (e.g., song lyrics, Cash App Fridays), low CAC ($5-$10), and product expansion (e.g., cash card, Bitcoin).
• Afterpay:
• Revenue Model: ~2%+ transaction fee on merchant sales, driving 20-30% conversion uplift.
• Price: Competitive BNPL rates, justified by merchant sales growth.
• Volume: ~20M consumers, 100K merchants, ~1M daily leads.
• Drivers: Two-sided network effects, merchant discovery, and integration with Square/Cash App.

Mix:

• Product: Square’s shift to integrated software and loans boosts margins; Cash App’s cash card and instant deposits are high-margin.
• Geo: U.S.-centric, with Afterpay expanding international reach.
• Organic Growth: ~50% gross profit CAGR, primarily organic, with Afterpay adding inorganic scale.

Cost Structure & Drivers

• Variable Costs:
• Square: Card network/issuer fees (~2% of transaction value), software delivery costs. ~18% of net revenue (yielding ~82% gross margin).
• Cash App: Interchange fees for cash card, Bitcoin transaction costs. Lower variable costs due to free P2P transfers.
• Drivers: Scale economies reduce per-transaction costs; data-driven fraud detection minimizes losses.
• Fixed Costs:
• Sales and marketing (~$5-$10 CAC for Cash App vs. hundreds for banks), R&D (product innovation), G&A (overhead).
• Drivers: Operating leverage from scalable technology and low CAC. Marketing spend increased recently for Cash App ($10 CAC).
• EBITDA Margin: Not disclosed, but high gross margins (~82% for Square) and low CAC suggest strong profitability, tempered by R&D and marketing investments.
• Operating Leverage: Significant, as fixed costs (R&D, G&A) are spread over growing revenue, especially in Cash App’s high-margin services.

FCF Drivers

• Net Income: Not disclosed, but high gross margins and operating leverage imply strong potential.
• Capex: Low, as Block is software-driven with minimal physical infrastructure. Hardware (card readers) is low-cost and scalable.
• NWC: Efficient, with short cash conversion cycles due to transaction-based revenue and third-party loan funding.
• FCF: Likely robust, given low capex and high margins, but M&A (e.g., Afterpay) and Bitcoin investments (~2% of OPEX) consume cash.

Capital Deployment

• M&A: Afterpay ($29B all-stock) enhances ecosystem connectivity; TIDAL and Weebly (~hundreds of millions) target niche markets. Focus on synergistic, mission-aligned acquisitions.
• Organic Growth: ~50% gross profit CAGR, driven by product innovation and market expansion.
• Buybacks: Not mentioned, suggesting focus on growth investments.

Market, Competitive Landscape, Strategy

Market Size and Growth

• Merchant Payments: ~$6T U.S. card payment volume, growing ~5-7% annually (volume-driven, with modest price increases).
• Consumer Financial Services: ~$1T+ U.S. retail banking market, with digital adoption growing ~10% annually.
• BNPL: ~$100B global market, growing ~20-30% annually, driven by millennial/Gen Z adoption.
• Industry Growth Stack: Driven by digital adoption, cash-to-card transition, and e-commerce growth, with inflation and GDP as secondary factors.

Market Structure

• Fragmented: Numerous players (banks, PayPal, Stripe, Adyen) with no single dominant leader outside Visa/MasterCard.
• MES: Moderate, as scale economies in technology and branding favor larger players, but low barriers allow niche entrants.
• Cycle: Mature but evolving, with digital and BNPL segments in growth phases.

Competitive Positioning

Block competes with traditional banks (e.g., JPMorgan, Citibank), fintechs (e.g., PayPal, Stripe), and niche players (e.g., Toast). It differentiates via:

• Customer Experience: Seamless onboarding, intuitive products, and cultural branding.
• Data Utilization: AI-driven fraud detection and lending enhance efficiency.
• Ecosystem: Two-sided network effects via Square, Cash App, and Afterpay.

Market Share & Relative Growth

• Square: 3M merchants vs. JPMorgan’s 4M businesses, with faster GMV growth ($200B) than traditional acquirers.
• Cash App: ~100M users vs. Venmo’s smaller base, with stronger user growth and engagement.
• Relative Growth: Outpacing market growth (~5-10%) with ~50% gross profit CAGR, driven by innovation and TAM expansion.

Competitive Forces (Hamilton’s 7 Powers)

1. Economies of Scale: High, with scalable technology and low CAC ($5-$10 vs. hundreds for banks). Enables pricing flexibility and margin expansion.
2. Network Effects: Strong in Cash App (P2P) and Afterpay (two-sided); emerging between Square and Cash App via closed-loop transactions.
3. Branding: Exceptional, with Square as a merchant ally and Cash App’s cultural resonance (e.g., song lyrics, streetwear).
4. Counter-Positioning: Disrupts legacy providers with instant onboarding and data-driven services, which incumbents struggle to replicate.
5. Cornered Resource: Proprietary data and technology stack for fraud detection and lending.
6. Process Power: Rapid product innovation (e.g., 40+ products) and customer empathy-driven development.
7. Switching Costs: Moderate, as merchants and consumers value Block’s ecosystem but face low contractual barriers.

Porter’s Five Forces:

• New Entrants: Moderate threat; low barriers but high scale requirements deter new players.
• Substitutes: High, with banks, PayPal, and crypto platforms as alternatives. Block counters with superior experience.
• Supplier Power: Low, as card networks and loan buyers are commoditized.
• Buyer Power: Moderate, as merchants and consumers are price-sensitive but value Block’s ecosystem.
• Rivalry: Intense, with PayPal, Stripe, and banks competing, but Block’s innovation and branding provide an edge.

Strategic Logic

• Capex: Low, with focus on software and minimal hardware, avoiding large capital bets.
• Economies of Scale: Achieved through technology and branding, with MES reached in both ecosystems.
• Vertical Integration: Limited, with reliance on third-party loan funding and card networks, but Afterpay enhances transaction control.
• Horizontal Integration: Afterpay and TIDAL expand into BNPL and music, aligning with the mission.
• M&A: Synergistic (Afterpay) and mission-driven (TIDAL), avoiding overpayment risks.

Valuation

Block’s $75B market cap reflects its ~$5B gross profit and ~50% CAGR. Assuming a 15x gross profit multiple (typical for high-growth fintech), the valuation appears reasonable but hinges on sustaining growth and network effects. Risks include regulatory burdens and trust erosion, while upside lies in closed-loop transactions and Bitcoin adoption.

Key Dynamics and Unique Aspects

Block’s business model is unique due to:

• Dual Ecosystems: Square and Cash App create complementary merchant and consumer platforms, with Afterpay as connective tissue, driving two-sided network effects rare in fintech.
• Customer Empathy: Deep understanding of underserved segments (micro-merchants, unbanked) informs product innovation, enabling viral growth and brand loyalty.
• Data-Driven Efficiency: AI-powered onboarding and lending disrupt legacy processes, achieving 99% merchant approval and low CAC ($5-$10).
• Cultural Branding: Cash App’s resonance with Gen Z (e.g., song lyrics, Cash App Fridays) and Square’s merchant advocacy create defensible moats.
• Closed-Loop Potential: In-network transactions (e.g., Cash App to Square) boost net take rates from ~1% to ~3%, offering pricing flexibility against competitors like Toast.
• Mission-Driven Innovation: The focus on economic empowerment drives bold bets (e.g., TIDAL, Bitcoin), expanding TAM and fostering trust.

Critical Observations:

• Block’s ability to maintain take rates while moving upmarket defies industry norms, driven by value-added services and brand strength.
• The Afterpay acquisition’s merchant discovery potential (~2B annual leads) could transform Block into a marketing platform, not just a payments provider.
• Bitcoin investments (~2% of OPEX) are speculative but align with the mission, with limited near-term financial risk.
• Regulatory and trust risks loom large, as scaling financial services could slow innovation or erode customer confidence.