Why Square’s Valuation May Be Too Low

Square recently raised another $150M from investors at a $6B valuation.  Talk about this valuation being outrageous and Square running out of cash and being the first of many tech companies to fold in the coming tech bubble apocalypse has been floating throughout the blogosphere.

But before we start hoarding our money in gold and Bitcoin, let’s take a look at other comparable public companies in the payment technology and payment processing industry.

Payment processing is a complex ecosystem with merchant acquirers, payment processors, payment networks, and all kinds of steps between the merchant and the bank that issues the credit card.

If we just look at the largest merchant acquirers, the field is dominated by large financial institutions like Chase, Bank of America, Wells Fargo, and Citi.  The biggest non-bank is First Data but they are owned by private equity firm KKR, who knows a cash cow when they see one.

As for public companies, the largest are Vantiv, Global Payments, and Heartland Payments.  These are companies that have been around much, much longer than Square.

It’s been estimated that Square processes $30B-$40B in transactions.  For comparison, here is the approximate transaction volume and market cap for the public comps:

Vantiv (NYSE: VNTV):  $600B / $6B

Global Payments (NYSE: GPN):  $200B / $5B

Heartland Payment Systems (NYSE: HPY):  $100B / $2B

Obviously, a lot more goes into a valuation than simply the volume of transactions processed, but it’s a decent proxy for understanding whether Square’s valuation is sensible.

Looking at the comps, the valuation / transaction volume ratio ranges from 0.01 to 0.025.  For Square, this would equate to a valuation range of $300M-$1B.

But as any investor knows, you pay a lot more for a fast growing company than for a slow growth company.  Most of these public companies are growing at annual rates of 5-10%.  Reports suggest that Square is growing at 50-100% YoY.

If Square continues to grow at 50% YoY from a base of $30B in transaction volume, it will surpass the $200B annual volume that Global Payments has in 5 short years.  That’s a lot faster than it took them.

One other data point.  Vantiv recently bought Mercury Payment Systems from private equity company Silver Lake Partners for $1.65B.  Mercury processed $30B per year in transactions, the same as Square.  It took Mercury 13 years to reach that point and Square has done it in 5.  The valuation / transaction volume ratio for Mercury, which is much more similar to Square than the other public comps, since both companies were payments technology companies instead of the actual processors, is 0.055.  At current growth rates, Square will match that ratio in 3 short years.

Time will tell, but investors may be kicking themselves in 3 years for not having the foresight to invest at such a low valuation.

Full-disclosure:  I previously worked at Mercury Payments.



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