Case 2 Questions: Square, Inc. IPO
1.
Initial Public Offering:
An IPO or Initial Public Offering is when a private firm is offered to the public for the
first time. Through an IPO a company can increase market value, attract attention and promote
their firm and increase cash and liquidity. Square Inc. is a perfect example of a company who
decided to go public for growth. Square is a company that aims to help small businesses easily
and afford to accept credit card payments. Square Inc was focused on growing and were in
capital need in order to invest in new products and services. In their income statements one can
see a loss of over $300 million three years prior. On November 6, 2015 square filed Amendment
No. 2 to the Form S-1. The amendment listed the estimated price per share to be $11 to $13, the
firm would expect to raise between $297 million to $351 million.
Square had raised over $520 million of private equity from 2009 and October 2014.
Investors were eager to see Square go public as they knew the return on their investment would
come by cashing out through the IPO. Another reason Square went public when it did was to be
part of the Jumpstart Our Business Startups (JOBS) Act which allowed growing companies to
file a confidentially for IPO. In order to file under the JOBS Act a company had to be under $1
billion of annual revenue to go public, Square was at $850 million the year prior.
When a company decides to go public it takes around three months to a year. Not only is
it a lengthy process it is also very expensive for the company. The first is hiring underwriters.
Underwriters typically charge a commission of 5% to 7% of the total amount raised in the
IPO. Other expenses include auditors, incentive plans and stock exchange listing fees. The
following step in the IPO process is forming the first version of the S-1 registration statement
filed with the SEC. This includes the company’s financials, identifies principal shareholders in
the company, proposes uses for the IPO funds, discloses legal concern, and identifies the risk in
the investment. Once they file with the Securities and Exchange Commission, the SEC reviews
the documentation for compliance with requirements. This part takes 2-3 months. Once the
company is approved the “Road Show” begins. On the road show the company's management
meets with potential investors. The underwriters also do “Book Building” which is essentially
pricing the stock based on demand from the investors. From this step they begin to discuss the
price they believe is suitable with the company and once the company and underwriters agree,
they set an IPO date.
Once the stock enters the secondary market the underwriter often has what is called a
greens hoe option. This is when underwriters exercise their over allotment option giving the right
to sell investors more shares than originally issued. In Square’s IPO their lead underwriter,
Goldman Sachs secured an over allotment option of 15% which they used 5 days after the IPO
date, and they raised an extra $36 million for the company.
There is asymmetric information between underwriters and the initial investors in IPOs
when they come into the market. To justify for this, underwriters underprice the company to
give investors a reason to take a risk. The less liquid the IPO is the more underwriters underprice
the security. IPOs usually increase within 15% to 20% within the first day, giving initial
investors a good return on their investment if they decide to sell. In Square’s IPO there was a lot
of uncertainty and in the initial price set. The estimated price was between $11 to $13 per share
but once they went public the price was $9 pers share. Quite the difference between the
estimated price and actual price of the share. The underwriters had underpriced the IPO as the
share increased by 45% the first day of trading and the ending price was $13.07.
One of the main reasons a company decided to go public is for the private investors to
gain a return on their investment. Restrictions such as the lock-up period are set in place in order
to avoid sending the wrong message to the market. This contract is done with insiders of the
company and prevents them from selling their shares for a specific person usually between 90 to
180 days from initial IPO date. In Square’s case this was 180 days. This helps the company
when dealing with asymmetric information as it gives the company time to find its equilibrium
price when it enters the secondary market. Even with this in place it does not stop from sending
adverse signals to the market if insiders decide to sell their stocks after the 180-day period.
When an investor decides to invest in an IPO, they are taking a risk. This risk affects the
company the investor is investing in and the investor themselves. There is no historical data on
the companies’ stock, and no one knows exactly how the market will react once it begins to trade
in the secondary market. Nonetheless investors usually have the upper hand as prices tend to be
underprices before hitting the secondary market and they have the potential to make a profit.
Institutional investors must rely solely on the underwriters pricing and information provided to
them to do their own analysis. They must make their own judgement call and see whether the
company is worth the investment.
Although institutional investors must take a big risk, individual investors must take an
even bigger risk as they do not have access to any relevant information like institutional
investors do. They have no price estimate. They also cannot buy the stock before it is already
trading and by the stock might have risen in price already. But there is still a benefit to investing
as they can still have capital gain if the stock is underpriced. This is what occurred with Square
as it rose from $9 to $13.07 on the first day.
2. Business Model:
Square Inc, has a solid ecosystem that generates revenue. This system can be broken into
three segments. We have transaction-based revenue, subscription and hardware sales. In 2018,
the company introduced bitcoin trading as a means to increase its market share. Most Square
revenue comes from transactions made through its platform. For each transaction, Square
charges a flat fee depending on the payment method. This fee can be breakdown into the
following:



2.6% + 10 cents per swipe or tap
3.5% + 15 cents for keyed-in transaction
2.9% + 30 cents for e-commerce transaction or invoice
As an important component of its business, Square utilizes a tool called Gross Payment
Volume (GPV) to evaluate their customers retention rate on a fiscal year. For example, in 2019,
the company processed $28.2 billion in GPV. This is a positive result as it shows an increase of
25% compared to 2018. In the meantime for the same period, the transaction-based revenue was
$817 million, a 25% increase, while its transaction-based gross profit was $297 million, a 23%
increase.
A deep look at the company's 2020 GAAP statement highlighted $1,633,764 revenue
from bitcoin, this is a 920% increase from December 2019. This all-time high bitcoin revenue
can be explained by the value of this cryptocurrency which priced above $15,000.
When analysing Square revenue portfolio, it's important to mention its strategy toward its
main competitors. In 2013, the company teamed up with Starbucks on a $25 million deal to
provide payment services for all Starbucks’ stores. This deal seemed to be an excellent solution.
However, although it brought some revenues, it also increased the company expenses. For
example, in 2013, Starbucks brought in sales $115 million but ended up costing the company
$140 million leading to a margin loss of 22.1%. This is a huge hit compared to Stripe which
teamed up with Lyft to offer a payment service for its 700,000 drivers with their near 1 million
rides per day. Despite this error, its subscription and hardware sales compensated the loss.
When we look at the company revenue segment from 2017 to 2020 as shown in the
following graph, we can see that we have a light increase in bitcoin revenue. From September
2019 to September 2020, it moved from $391341 to $2992885, which is an increase of 764.78%.
Compared to its competitors, Square also offers small loans to businesses through Square
Capital. This feature allows businesses to borrow up to $100000 plus commissions. The loan
repayments are automatically deducted from the company daily sales.This retention strategy
allows Square to keep their current customers while targeting a new segment. Its hardware sales
includes Square payroll for small businesses. Both hardware sales and loans could be explained
why the company is doing so well.
Our second graph emphasizes the impact of Bitcoin revenue over the company's overall revenue
performance. In September 30, 2020, its bitcoin revenue had increased by approximately
1001.8%. The company said that it generated $1.63 billion in Bitcoin revenue and $32 million of
Bitcoin gross profit during the third quarter of 2020 from its Cash App. Including Bitcoin
earnings, Square's net revenue rose 140% year-on-year to about $3 billion in the quarter (Shalini,
2020).
Graph 2: Cash app ecosystem
Source: Graph created based on Square historical financials Q3 2020