After Afterpay: The Bitcoin in Square's Sights

Square’s all-stock bid to buy Afterpay for A$40b is both its largest acquisition and the largest deal in Australia’s corporate history, both very impressive superlatives. The deal is “synergistic” and “transformative” and the respective technologies and services are “complementary” and earnings “accretive”.

Behind the PR-spin, Steve Sammartino makes the case that Afterpay’s business was already coming under increasing competitive pressure and that therefore the deal is a good one for Afterpay shareholders who want to sell and get out.

But what about those Afterpay shareholders who might be considering keeping their 0.375 Square shares for every Afterpay share?

Let’s consider why Square and Afterpay believe this marriage will be fruitful in the long run.

Jack Dorsey, Square’s founder and CEO, says that both companies share a similar founder-led management team and a cultural focus on empowerment and financial inclusion for both consumers and sellers (aka merchants).

Afterpay’s Co-Founders and Co-CEOs Anthony Eisen and Nick Molnar will also join Square upon closing of the transaction and will run the respective Afterpay businesses in Cash App and Seller, led by Square’s Brian Grassadonia and Alyssa Henry, respectively.

Both companies serve consumers and sellers and earn fees from both.

1. Square plans to add Afterpay into its Seller ecosystem for both in-store and online payment. This means Square’s millions of merchants worldwide, including over one million in the USA alone, will be readily able to accept Afterpay as a means of payment.
2. Square will integrate Afterpay directly into Cashapp so that Afterpay’s 16 million consumers can manage their accounts inside Cashapp, and Cashapp’s 70 million consumers can pay with Afterpay.
3. Square will take advantage of Afterpay’s in-app “seller discovery” which is basically a way for sellers to promote themselves to consumers directly from within the app.

Each gains access to each other’s distribution channel to sellers and consumers, which should lead to increased transaction sales value over time. Square becomes a leading buy now, pay later (BNPL) business in one hit and Afterpay gets access to Square’s other financial services including person-to-person (p2p) payments, share broker services and exposure to Bitcoin.

Yes, Bitcoin. Jack Dorsey and Square are big on Bitcoin. His Twitter profile illustrates this (he is also the founder and CEO of Twitter).

Dorsey has become a highly visible and committed flag-bearer for Bitcoin and Square holds around $US450 million of Bitcoin on its balance sheet. Square also sold over $US3.5 billion worth of Bitcoin to customers in the first quarter of 2021 alone, making $US75 million in profit (a 2 per cent margin). Annualised, this is a staggering $US14 billion in Bitcoin sales.

Square’s lead hardware designer Jesse Dorogusker tweeted that Square plans to develop a Bitcoin hardware wallet. Dorsey also said that they would create an open-source developer framework for Bitcoin (and maybe other crypto) related services.

This seems an obvious play given Square’s seller and consumer reach (including the incremental uplift from Afterpay sellers and consumers) and its existing hardware payment device business. It’s very likely that Square will incorporate Bitcoin’s layer 2 Lightning Network that supports virtually instant transaction authorisation and settlement of Bitcoin payments and add this to its p2p and seller payment acceptance functionality.

Adding millions of potential Bitcoin holders and users won’t hurt the Bitcoin price either (due to Bitcoin’s limited supply), and Square’s Bitcoin reserves will benefit from this tailwind.

For Afterpay shareholders, the question is whether to sell, or retain an exposure to the growth potential of the combined business.

In isolation, Afterpay’s merchant fee of around 3-4 per cent is considerably more expensive than the fees typically involved for accepting Visa, MasterCard and eftpos (although not so far from American Express merchant fees). So the question is how long can this train keep running?

The dramatic growth in BNPL in recent years has demonstrated that merchants are prepared to accept higher costs in return for increased sales, especially from millennials and Gen Z consumers. Afterpay’s gross transaction value growth during FY19-21 was 105 per cent compounded annually, and its year-on-year growth in profit only slightly less.

The integration of Afterpay functionality with Square’s ecosystem opens up an enormous pool of sellers and consumers, particularly in the US. Consider that Afterpay currently has around 100,000 sellers compared to millions of Square sellers. If Square can successfully execute a cross-selling strategy then the market potential remains significant.

Square won’t have it all its own way. Visa, MasterCard and Paypal are all now playing in the BNPL space, and Apple plans to partner with Goldman Sachs to develop an offering. Apple could be a significant threat due to its ability to integrate BNPL into Apple Pay. Increased competition will drive down merchant fee margin and potentially reduce transaction sales value across the platform (or at least reduce the rate of growth).

How successfully Square and Afterpay can navigate these threats will determine the outcome in the years ahead.

Some investors might be nervous about Square’s fascination with Bitcoin. But this is consistent with Square’s strategy as a fintech disruptor.

Investors who are hesitant about the future of crypto should be cautious. The fact is that Square and Jack Dorsey are committed to a crypto future and are investing resources and management time to accelerate it.