Block Still Paying For Afterpay Acquisition

Australia | Aug 11 2022

This story features BLOCK INC. For more info SHARE ANALYSIS: SQ2

Block’s BNPL segment continues to drag on portfolio performance, but brokers largely continue to back the integration opportunity for Afterpay and Cash App.

-Afterpay acquisition fails to deliver for Block in the second quarter
-New products, including the recently launched Borrow loan product, should offer diversification
-Competition looks to intensify, with some brokers anticipating industry consolidation ahead

By Danielle Austin

There appears plenty of opportunity in Block’s ((SQ2)) recent acquisition of buy now, pay later platform Afterpay, but as integration of the purchase continues to progress the company is yet to deliver on potential.

At the close of the second quarter the company reported total gross profit was up 29% year-on-year, with Afterpay’s $150m contribution representing a -2% decline for the business, and the drag from Afterpay is expected to have continued following the second quarter, with the business expected to deliver just 1% growth in July.

Positive commentary around Block’s Cash App was a highlight of the result, with the company reporting 47 million monthly users, acceleration in daily and weekly activity growth, and record quarterly inflows. Having achieved 20% gross profit growth in the second quarter, the Cash App is expected to deliver 32% gross profit growth in July.

Integration of the Afterpay and Cash App platforms continues to present a key opportunity for Block, allowing the company to offer consumer platforms with access to a range of lending and banking services products.

Block also released its new short-term lending product during the quarter, offering loans under $200 per month that can be repaid in instalments through the platform.

Shifting trends and intensifying competition

Block management appears to have taken a conservative view on the coming second half, cautiously reducing investments in response to a more volatile macroeconomic environment, and citing increasing competition from pure-play BNPL peers as a concern.

The company highlighted a trend shift in spending mix away from utilising BNPL products for online purchases, and towards using the platforms in-store.

Of FNArena’s database brokers, Credit Suisse, Morgan Stanley and Macquarie have reported on Block’s second quarter result. Macquarie retains a Neutral rating and has lifted its target to A$130 from A$97. Morgan Stanley also has a Hold-equivalent (Equal-Weight) rating but has cut its target to US$85 from US$110. Credit Suisse has an Outperform rating and has left its target unchanged at US$125.

The target cut from Morgan Stanley represents a desire to see greater investment in, and faster availability of, a wider range of credit products. The broker sees long term potential in a Cash App and Afterpay integration that brings banking and lending services to the underbanked younger generations in the US, but notes an ability to accelerate and launch credit and banking services products on consumer platforms will be key to Block’s outlook. The broker highlighted limitations to Cash App’s Borrow, and Afterpay’s interest-free model, given that both can only finance smaller and shorter-term loans. Morgan Stanley’s updated forecasts predict 36% gross profit growth year-on-year, estimating total gross profit of $6,011m.

Macquarie reiterated a favourable view of Block’s legacy business (Square payment system), which it described as pulling the weight of the company’s recent result. Looking ahead, the broker cautions cost controls will come into play to support management focus on profitability. The broker previously warned of Afterpay continuing to drag on the remainder of the portfolio and continues to see risk here, noting more stabilisation of Block’s BNPL segment would be needed to support a more positive outlook. On the back of Block’s second half result, Macquarie lifted earnings per share forecasts 37-66% through to FY24, and 25-37% in outer years. By product, the broker is anticipating Cash App to deliver 21% gross profit growth in July, Square 14% and Afterpay 1%.

Credit Suisse has lifted its earnings estimates to account for Block reducing its operating expense growth, removing longer-term and experimental sales and marketing and slowing hiring. The broker is anticipating Cash App and Square to achieve full year gross profit growth of 40% and 24% respectively. Credit Suisse anticipates industry consolidation will occur over the next decade, but finds Square well positioned to remain a leading digital financial services platform in the US.

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