Square + Afterpay

Early in August, US listed Square Inc, a global payments and financial services provider announced the proposed ‘friendly’ acquisition of Afterpay. The transaction has been endorsed by the Afterpay board and if it proceeds as expected, Afterpay shareholders will receive 0.375 shares of Square for each Afterpay share that they own. Given Square is listed in the US, they have agreed to establish a secondary listing on the ASX to allow Australian Afterpay shareholders to trade Square shares domestically (similar to other global companies such as James Hardies and Resmed). As Square is a key position in the Global Fund, we are pleased to be able to include it in the ELMRI ANZ Conviction Fund.

We previously chose not to invest in Afterpay due to its core buy now pay later service, which we thought facilitated overconsumption, fuelling unsustainable growth in retail sales. However it became clear to us that the company was evolving to become a much broader and diverse financial services company by offering more conventional products such as debit cards and deposit accounts, specifically for younger customers who have tended to shun traditional banks. As Afterpay’s financial services product offerings expanded, our view on the company also evolved.

Founded in 2009, Square’s initial goal was to help micro-merchants accept payments in a simple and affordable manner through their point-of-sale hardware and software. The company then expanded into other offerings such as capital, invoicing and payroll, further improving the efficiency of small businesses and lowering their administrative costs. Given the importance of small business to the economy, employment and diversity, we are attracted to listed companies that are developing solutions for them and so Square became an important holding in the Global Fund. Past research on Square can be found here.

Although their initial focus was on merchants, Square launched the Cash App, a consumer finance app in 2013. The Cash App offers core financial services products such as bank accounts, payments, and investment options, particularly to underbanked and unbanked customers. In the US, it is estimated that there are tens of millions of individuals without a credit score, and so we think that Square provides an important offering particularly to those individuals.

Square’s two-sided ecosystem (merchants and consumers) means that payments can be made directly from the consumer to the merchant through the Square platform, bypassing traditional banks and payment systems, lowering the transaction cost of commerce for small businesses and consumers. Although Square is growing organically, we think that their acquisition of Afterpay is compelling as it will accelerate their growth (Afterpay brings 16 million active users) and give them access to the popular buy now pay later feature which will be integrated into the Cash App. Furthermore, given Afterpay deals primarily with enterprise clients, the acquisition will diversify Square’s mostly micro-merchant base to include larger and more established enterprises.

Square’s highly effective and innovative technology platform is expected to grow its share of the very large total addressable markets that it serves, currently estimated to be US$100 billion for merchants and $60 billion for Cash App. With one of the lowest customer acquisition costs and strong network effects present in its core divisions, we believe Square has an enduring competitive advantage relative to industry incumbents. As Square has <3% market share in its respective operating segments, we see a long runway for growth. We also think that the company is contributing positively to the world as it provides a reputable alternative to banks for underbanked and unbanked individuals. Their ecosystem also has the potential to lower the administrative costs of small businesses and the overall economy.

This note has been prepared by ELM Responsible Investments (‘ELMRI’) ABN 70 607 177 711 AFSL 520428, for Australian wholesale clients for the purposes of section 761G of the Corporations Act 2001 (Cth).

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Past performance is for illustrative purposes only and is not indicative of future performance.