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Square (NYSE:SQ) takeover: Time to sell Afterpay ASAP? Not so fast…

For Aussie tech investors, the biggest news since sliced bread came this month, in the form of a $39 billion offer from Square Inc (NYSE: SQ) for Afterpay Ltd (ASX: APT). Afterpay shareholders are now left wondering ‘what should I do?’

This article first appeared as an email in Rask’s Weekly Market Report — sent every Monday morning at 7 am. You can go on the list to receive Owen’s weekly column, plus a free report on where to invest $10,000 right now — by clicking here and getting our free investment report. 

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Here’s this week’s story…

Afterpay + Square = ?

For Aussie tech investors, the biggest news since sliced bread came this month, in the form of a $39 billion takeover offer from Square Inc (NYSE: SQ) for Afterpay Ltd (ASX: APT). Afterpay shareholders are now left wondering ‘what should I do?’

I’ll try to help you answer this, by taking a look at Square.

For those who aren’t familiar, Square was started by Twitter Inc (NYSE: TWTR) Founder Jack Dorsey.

Right now it’s a $127 billion diversified technology company. It’s also one of the so-called ‘meme stonks’ – it’s currently ranked #62 on the Top 100 Stonks list. That’s based on stock trades on Robinhood – a big US broker for younger investors.

Square was best known for helping small businesses and craft market type hobbyists take card payments for their products.

Chances are, you’ve seen the little white ‘square’ payment devices sitting next to a nice white POS (Point of Sale) device at a cafe or restaurant.

Today, however, I’d say Square is best-known for its ‘Cash App’.

Like PayPal Inc (NASDAQ: PYPL), a company I own and recommended to Rask Invest members, the Cash App is attempting to be an ‘all in the one’ style service on your phone. You can use it as a transaction bank account, buy or sell crypto assets, invest in shares or ETFs, take part in exclusive retail offers, and so on.

About the same time the deal to buy Afterpay was announced, Square served up its latest batch of quarterly numbers. It noted that its active (transacting) user base hit 40 million customers and gross profit had jumped 94% year over year to $546 million.

Outside of the Cash App, Square reported $1.14 billion in gross profit and net profit of $204 million. In other words, both the Cash App and ‘Seller’ part of Square’s business is growing fast.

Side note: you should know that I ‘passed’ on buying Square shares during the COVID crash of 2020 because I was worried about the company’s move to fund small business loans (i.e. loans going bad). At the time the stock was trading around $40 — it’s now $275 — meaning I missed out on a 587% return. Yikes!

Afterpay + Square = bigger & better

What’s now become very apparent to me is that Square is pushing very hard to monetise what it already has. Bolting on Afterpay’s users and ecosystem is perfect, therefore, as Afterpay would be able to kickstart Square’s user growth numbers via the addition of its highly optimised customer acquisition funnel.

As my podcast co-host Anirban Mahanti, PhD said this week (see the most recent Investors Podcast episode), Square is a great business, but it’s basically only a US + Australia story.

It’s basically Afterpay’s business in reverse: Afterpay started in Australia then moved to the USA, and it’s now a big online player, having started in store.

Let’s compare Square to PayPal and its super-popular Venmo app. PayPal has a global audience and is currently 10x the size of Square, based on user accounts. However, Square is currently generating $55 per customer (up 2.5x from two years ago). Meanwhile, PayPal generates ~$61 by my count.

That said, customer velocity counts. More so in payments than anywhere else. While PayPal is 10x the size, an active Square user conducts 18 transactions per month, since they can do so much from one app.

Overall, a PayPal user engages with the service 43.5 times per quarter.

Finally, Afterpay users make multiple purchases per month.

All this means that Square will become even more relevant to its user base than ever. And so will Afterpay with its users.

Moreover, Square will have yet another big lever to monetise its “Sellers” (merchants/retailers/restaurant) because as we know Afterpay takes a big pound of flesh from every transaction — and the Seller pays the price.

Finally, I’ll add one more note. I think this deal is valuable to both parties because it’ll greatly increase Square’s footprint across the customer value chain.

Afterpay is an in-store payment service, sure. However, I believe its biggest opportunity lies ahead, in its e-commerce channels — directing millions of users to retailers across Australia and the USA.

Buy, Hold or Sell

Assuming an Afterpay shareholding would be a reasonable size in my portfolio, I’d strongly consider holding on to get some shares in Square. Indeed, while Square’s valuation flies in the face of conventional ‘valuation’, I think it’s an impressive business with more growth ahead.

However, it’s not risk-free. It faces competition from PayPal, Apple Inc (NASDAQ: AAPL), big banks, Google/Alphabet, FinTechs and many other companies trying to solve the money-meets-tech problem. Square shares will also be very volatile. Then there’s the currency risk of holding a US stock from Australia.

So, keep your wits about you.

And before you do anything, listen to my most recent episode of The Australian Investors Podcast. In it, Anirban and I talk Square, Afterpay, ways to save money, and lots more.

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At the time of writing, Owen owns shares of Apple, Alphabet/Google, PayPal & Volpara.