Wedbush Sees 'Saturation Approaching' At Square, Downgrades To Underperform

Square Inc SQ reported solid 1Q results and raised its guidance. Wedbush’s Gil Luria downgraded the rating for the company from Neutral to Underperform, while reducing the price target from $11 to $9. The analyst commented that Square’s business may “never reach peer (or guided) profitability.”

Analyst Gil Luria expects Square’s growth to decelerate over the next two years due to competition and saturation. The company is likely to face intensifying competition from PayPal Here, Intuit, SaaS competitors and traditional acquirers.

Square total addressable market is estimated at below 5 million SMBs, which implies Square is “close to saturation,” Luria said. Early signs are already visible, with lack of merchant count growth over the prior few quarters; and this may be causing Square to increase its already market-high ad spending, “in what appears to be scattershot manner.”

Margins Capping

Square has a “high-cost software company expense structure,” while its monetization is of a commodity payments company. This puts a cap on peak margins, the analyst mentioned.

While the SMB loan broker business appears to be a risky growth engine, the current software business may not be able to offset the impact of the challenging credit market conditions.

“We do not believe investors will be impressed with LSD Adj. EBITDA margins in 2016, especially as this excludes 18% of adj. revenue going to Stock Based Comp,” the Wedbush report stated.