Square is finally, officially, really ready to go public.
Which increasingly seems like a terrible idea.
After many rumors, Jack Dorsey's six-year-old payments startup filed its IPO prospectus this week, unveiling its plans to try to raise up to $275 million. It's the first time that Square has fully disclosed its financials--and they're not pretty. Worse, they disclose fundamental problems with Square's ability to grow, or to ever turn a profit.
I'm not just talking about Square's losses ($154 million in 2014, which the company's on track to match this year), its disastrously expensive deal with Starbucks (which cost it $28 million in 2014), or Dorsey's other CEO job at Twitter (which, as the Square prospectus drily notes, "may at times adversely affect his ability to devote time, attention, and effort to Square." True! It may!).
The first two problems, at least, could be overcome--especially if Square figures out how to expand into new businesses, with new sources of significant revenue. But despite several efforts, it hasn't yet.
Square still makes 95 percent of its revenue from processing payments, it admitted Wednesday. And processing payments, for Square, is a very expensive business, burning two-thirds of every dollar it brings in. That's a pretty shoddy profit margin for a business that boils down to sending electronic messages back and forth. We're not making cars here.
And: This isn't the typical tech-startup burn rate that will diminish over time; these aren't startup expenses to hire lots of people, build up sales and marketing, or develop shiny new products. Square has some of those, too, but they're outstripped by the fixed transaction costs that are growing along with the company's core business.
In 2013, Square spent $278 million to process $434 million worth of payments; last year, it spent $451 million to process $708 million. In the first half of this year, transaction revenues grew healthily, to $471 million in six months. So did related costs: $299 million in the same period.
That makes Square's transaction costs-to-revenue breakdown (or what a bank would call an efficiency ratio) consistently more than 60 percent. As a rough--and perhaps unfair--comparison with a much more established competitor, PayPal's transaction efficiency ratio is 30 percent: It spent $1.2 billion on transaction costs in the first six months of 2015 to process $3.9 billion of payments.
Square spends this money paying the interchange or "swipe" fees charged by banks and credit card networks like Visa, MasterCard, and American Express. Traditionally, retailers and their banks would pay those fees directly. Square's appeal--and the reason it caught on with so many coffee shops, farmers' markets, and other small businesses--is that it takes on the complicated and expensive interchange system for the merchants, charging them instead a 2.75 percent flat fee on most credit card transactions.
That doesn't leave Square a lot of wiggle room if the credit card companies decide to raise interchange fees: "Because we generally charge our sellers a flat rate," higher swipe fees "could make our pricing look less competitive, lead us to change our pricing model, or adversely affect our margins," the company said in its prospectus.
The answer, of course, is to look elsewhere for revenue growth. And Square has been doing that, for a long time, without much apparent success. This goes beyond the Starbucks debacle: Small businesses love Square's simple, easy, plug-and-play credit card processing services, but so far they haven't shown much desire for its failed mobile wallet, or its late-to-the-party cash-advance services, or its food-delivery options.
Square knows this, and even spells it out in typically dry, regulatory-filing jargon. "The growth of our business depends in part on existing sellers expanding their use of our products and services," the company says in the prospectus. "If we are unable to encourage sellers to broaden their use of our services, our growth may slow or stop, and our business may be materially and adversely affected."
Six years as a small, closely held, well-funded upstart haven't helped Square solve this problem. It's hard to see how life catering to the loud, distracting, and crowded public markets will cause a breakthrough.