Afterpay and Square owner Block’s (SQ) share price tumbled 15% to a $61.88 close on the NYSE after Hindenburg Research published its detailed accusatory report on the company. 

The Hindenburg report on Block was 2 years in the making, alleging that the company has firstly knowingly and willingly facilitated fraud against consumers and the government, and also been ignorant to criminal activity occurring via its subsidiary - Cash App.

Due to the app’s relaxed compliance and AML regarding user account creation, the App has become prominent in the world of crime. Hindenburg alleged, on the back of ex-employee screenshots, that users of blacklisted accounts were often connected to dozens or hundreds of other active accounts suspected of fraud.

Furthermore, Hindenburg asserts that the Fintech giant has “wildly overstated” its genuine user count and understated its user acquisition costs, providing misinformation to its investors during Cash App’s post-pandemic user surge. According to some former employees of Block, 40%-75% of accounts were either fake, involved in fraud, or part of a network of accounts made by a single user.

Finally, Block has been accused of gouging merchants and users via elevated fees and predatory pricing. An example provided was the avoidance of government regulations of an “interchange fee” cap applicable to banks with over $10b in assets. Block has $31b in assets and is accused of routing funds through smaller banks to avoid the fee, allowing them to charge merchants significantly higher fees.

Jack Dorsey, who has self-proclaimed the title of “Block Head”, has responded that the report was “designed to deceive and confuse investors,” and that the company is “highly regulated with regular disclosures, and [the company] is confident in their products, reporting, compliance programs and controls.” He said the firm was exploring legal action against Hindenburg for the “factually inaccurate and misleading report”.

The report comes after Block’s 78% fall from its peak in August of 2021. Regardless of the report, it is obvious that the company, like many of its growth stock peers, had lost the lustre experienced during the COVID rally.

In fy22, Block only reported a 1% net revenue increase and a $540.7m net loss. FactSet estimates point to further losses to continue in 2023 at $208m. Regarding Cash however, revenues increased 53% primarily due to growth in the number of active Cash App Accounts. Additionally, the app is showing signs of stagnation with slowing inflows and account growth (declining from 54% in 2021 to just 13 % in 2022).

Despite this, multiples continue to trade far above peers at EV/EBITDA multiple of 60x, forward 2023 “adjusted” earnings multiple of 41x, and a price-to-tangible book ratio of 13.1x. In Comparison, Block’s major competitor, Paypal trades at an EV/EBITDA multiple of 16.6x, and 15.1x adjusted 2023 earnings, and also had a $4.169b profit and an 18% net revenue increase driven by total payment volume of 33%. Matching Paypal’s more reasonable multiples would imply a 62%-72% downside for Block.

Indeed, Bitcoin’s major price decline since November 2021 did place a dent in Block’s net revenue. Yet, the recent Bitcoin rally has not been able to buoy the share price. It seems investors have been wary about buying into Block.

Part of this could be attributable to its Co-founders Jack Dorsey and James McKelvey offloading $1b during peak between Nov 2020 to Oct 2022. Dorsey sold 2.5m shares while James McKelvey sold 2.2m.

At this point, there is significant uncertainty surrounding the company and where its stock is headed. This will largely depend on how the company fends off the accusations and whether the market can look past the report. 

In the short to midterm, we are neutral verging toward the bear side. Our outlook may however change depending on how the markets digest the news in the following weeks. Furthermore, we believe it will be difficult for Cash App to maintain its previous growth as Block is likely to face scrutiny and pressure to increase compliance and AML precautions.

A Block and A Hard Place. Hindenburg Research Takes Aim

Mar 24 2023