Announcing Blocks’s Q4 2022 results, Jack Dorsey wanted to look serious about making money. With a stock price down two thirds since its pandemic peak, Block’s founder and CEO didn’t mention Bitcoin once. Instead, he told investors that he was making financial discipline the cornerstone of the company’s strategy. Going into 2023, he explained “each of our ecosystems must show a believable path to gross profit retention of over 100% and Rule of 40 on adjusted operating income.”
The profit retention target requires each cohort of customers to generate more profit than the previous year. Dorsey said: “In the simplest terms, it means that our customers find value in our offerings and want to stick with us.” Cashapp and Square both met this test in 2022 but the mere fact of measuring cohorts is something that other payment companies, especially the unicorns, could learn from.
The second new test, the rule of 40, is a common yardstick used by software businesses. It states that the sum of profit margin and revenue growth should be greater than 40% and is said to encourage a focus on growing profitable revenue. Profit, of course, is a matter of opinion, so it’s to Dorsey’s credit that he’s going to define this measure based on operating income not EBITDA. This is welcome recognition that employee stock compensation and depreciation/amortisation are costs to the stockholders even if they are not cash costs to the business. In 2022, this measure was 23% when excluding the one-off boost from the Afterpay acquisition. Management will now need to focus on growing both top and bottom lines..
Cost control will be getting close attention. Although it hasn’t made layoffs, Block has slowed the pace of hiring. It expects to increase headcount 10% in 2023 compared with 46% growth in 2022. Sales and marketing expense will moderate to 5%-10% growth compared to 25%.
Square, Block’s original proposition is the area which most interests us at Business of Payments, and continues to outperform traditional payment processors. But the years of explosive growth are gone, not least because of Square’s focus on Main Street SMBs. As a result, Square seems to be making relatively slow progress in eCommerce. Square gross payment volume (GPV) was up 14% to $49bn in Q4 2022. Card present was up 17% and “card not present” grew just 9%. Management called out “moderation in the GPV growth rates for discretionary verticals in the U.S. beginning in November, primarily for food and drink and retail.”
Plans to verticalize Square seem to be progressing nicely. CFO Amrita Ahuja revealed that Square is “in the early stages of building out a software-led-with-embedded-financial-services sales team” with a focus on restaurants, retail and services. Only a minority of merchants now use the simple Square card reader. Most adopt more sophisticated tools. Ahuja explained “software plus integrated payments have become the significant portion of the Square business, 75% of Square’s gross profit.”
44% of Square profit comes from merchants taking four or more products compared to 29% three years ago. Mid-market sellers (>$500K GPV) with four or more products have 15x greater retention than those with just one which also helps the cohort profit retention target that Block is now highlighting. Square sees $500K-$10m GPV as the sweet spot and makes up half of its US addressable market.
In contrast to the steepling growth seen when the proposition launched in the USA, international expansion of Square has been a more modest affair. Non-US GPV grew 23% in Q4 (or 39% at constant currencies) with profits growing the same percentage to $83m, excluding BNPL. The international business is steady at 10% of total Square gross profits.
Square aims for product parity across its international markets and has introduced Square for Retail and Square Appointments in Australia, and Square Appointments in Ireland. During 2022, Square originated $400m of small business loans in its international markets and claims that loss rates are similar to the US.
Square’s other business is Cashapp and it’s turning into a monster. With 51m monthly active users, it now makes as much gross profit as Square and has no less than five revenue streams with more than $100m gross profit: Instant deposit, Cashapp card, business accounts, Cashapp Borrow and Bitcoin.
It’s understandable that Dorsey doesn’t want to talk much about crypto. Block’s Bitcoin revenue was down 29% in 2022 although the business seems to have stablised. Q4 revenue was down just 7% at $1.8bn. Buying and selling Bitcoin is a low margin operation. That $1.8bn revenue line generated just $35m gross profit at 2% margins. The total value of Bitcoin held by Block on behalf of its customers fell from $1.1bn to $428m from Dec 21 to Dec 22.
Despite changing the name of the company from Square to Block in recognition of its high state of excitement about decentralised finance, management didn’t mention Bitcoin once the investor call and none of the analysts asked about it. The $220m Bitcoin that Block purchased “for investment purposes” has been written down to $102m. But Dorsey is not giving up. Block recently led an investment round in a Kenyan Bitcoin miner.
