Wall Street Punishes Square Despite the Merchant Processor’s Transaction Growth

Ouch. Merchant acquirer Square Inc. reported after Thursday’s market close that payment volume grew 45% year over year in the first quarter to $10.3 billion, but the company’s stock still fell 22% on Friday.

Despite the strong payments growth, investors didn’t like a number of things they saw in San Francisco-based Square’s earnings report, its second since its initial public offering last November. The negatives included a quarterly loss that doubled from a year earlier to $97 million. Operating expenses jumped 72%, and Square set aside $50 million in advance of a lawsuit settlement. Per-transaction revenues were flat, and per-transaction profits were down slightly.

But some analysts’ reports after a conference call with chief executive Jack Dorsey and chief financial officer Sarah Friar also focused on what they perceive as problems with Square’s loan service for merchants, called Square Capital. Originally a merchant cash-advance product, Square is converting Square Capital into a loan program with a Utah bank and outside investors. Square Capital lent $153 million in the first quarter, triple the amount a year earlier, through 23,000 advances and loans. But growth from 2015’s fourth quarter was only 4%.

It in its earnings report, Square said the low sequential quarterly growth was “largely due to the delayed signing of two new investors, which was a result of more challenging credit market conditions.”

Square thus finds itself exposed to the vagaries of the credit markets while delving further in the highly competitive small-business loan industry. Big players in the business include American Express Co., PayPal Holdings Inc., CAN Capital Inc., On Deck Capital Inc. and Kabbage Inc. The newest entrant is Shopify Inc., an Ottawa, Ontario-based e-commerce platform and merchant processor.

But there are dozens more. Jared Drieling, business intelligence manager at The Strawhecker Group, an Omaha, Neb.-based merchant-acquiring consultancy, keeps a list the players in the merchant-lending niche.

“There are a good 25 that have loan volumes of $20 million or more a year,” Drieling tells Digital Transactions News, adding that there are more providers below that threshold.

While Square Capital is easy for merchants to use, with repayments taken out of a merchant’s payment volume, the sheer amount of competition among small-business lenders could make it hard for Square to stand out, according to Drieling. He alludes to the company’s card-accepting dongle for smart phones, which was unique when Square introduced it about six years ago, but competitors quickly copied it.

“Just as Square’s dongle solution became a commodity very quickly, the same thing is happening with cash advances,” Drieling says. “I think it’s going to be difficult to compete against the PayPals and Shopifys of the world.”

Still, Square is optimistic that Square Capital will prove a success. The earnings report says the two investors came on board in late April “and have recently begun to ramp funding.” Friar said at the earnings call that the change from a cash-advance product to a loan program didn’t dampen merchant enthusiasm for Square Capital. “There’s still tremendous demand,” she said.

The $50 million Square allocated for legal expenses was for a pending settlement with Robert E. Morley, who worked with Square co-founders Dorsey and Jim McKelvey early on and is a Washington University professor. He claims the intellectual-property rights to Square’s smart-phone card reader and some other technology.

Square’s shares closed at $10.22 Friday on the New York Stock Exchange, down $2.83 per share from Thursday’s $13.05 close.