Why Square Has Mismatched Cost And Monetization Structures

• The share price of Square Inc SQ has appreciated 9.4 percent over the past month, reaching a high of $13.49 on December 31.
• Wedbush’s Gil Luria has maintained a Neutral rating on the company, while lowering the price target from $12 to $11.
• Luria believes that the stock valuation will be range bound till the company has the expense structure of a software company but the monetization of a payments company.

Analyst Gil Luria, however, also believes that “Square will remain a fast growing driver of innovation in the payments industry with one of the most impressive management teams in our technology coverage.”

The company’s total addressable market is now expected at less than 5 million SMBs, rather than the earlier 21 million, which means that Square could be close to saturation. Although there are 28 million registered companies in the U.S., Luria pointed out that B2B business are not truly an addressable market for payments acceptance.

According to the Wedbush report, the company’s margins “are structurally lower than other acquirers due to its headquarters location, generous stock-based compensation, lack of lead generation and transaction losses.”

This cost structure is likely getting worse, with the rise in fraud rates, and the company needs to make higher investments in TV advertising and hardware subsidies, as compared to traditional acquirers that have built-in referral networks from banks.

Luria also believes that Square’s high exposure to unsecured lending could lead to a sharp decline during an economic downturn, since the company would need to limit lending.

The EPS estimate for 2016 has been lowered from $(0.50) to $(0.36).