What you should look for in Square’s expected IPO filing

October 8, 2015, 4:32 PM UTC
Twitter's Dorsey Vies With SoftBank's Son for Japan Shopkeepers
Fumiko Yajima, owner of vegetable store Suika, swipes a credit card through a Square Inc. card reader plugged into an Apple Inc. iPad at the store in this arranged photograph taken in Tokyo, Japan, on Thursday, Oct. 10, 2013. Consumers in Japan paid cash for about 56 percent of their 279 trillion yen of purchases last fiscal year, while 12 percent was paid with plastic, Tokyo-based card company Credit Saison Co. estimates. Photographer: Yuriko Nakao/Bloomberg via Getty Images
Photograph by Yuriko Nakao — Bloomberg via Getty Images

Payment technology company Square is expected to reveal details about its buzzy business in the coming weeks when it publicly files for an initial public offering. If so, potential investors will be paying close attention.

The San Francisco company is part of a generation of hot startups valued in the billions of dollars. But their financial maturity is a concern.

Jack Dorsey, Square’s CEO, puts an even greater spotlight on an IPO. He is a well-known Silicon Valley figure who, earlier this week, took on the additional high-profile role as Twitter’s permanent CEO. The decision immediately sparked an intense debate within the tech industry. Could he really effectively manage two companies simultaneously?

Square’s path to an IPO started this summer, when it submitted a confidential filing to federal regulators under the JOBS Act, an option for companies with less than $1 billion in annual revenue. Everyone is now waiting for a required public filing, which signals that the IPO could happen as soon as a month later.

Square declined to comment.

In any case, Dorsey and his team will have to present a clear vision of why analysts, fund managers, and investors should buy the company’s stock. Tony Ursillo, senior equity analyst and portfolio manager at mutual fund Loomis, Sayles & Co., will be one of those fund managers taking a close look at Square’s financials. We asked Ursillo what he would look for when evaluating Square’s filing and deciding whether to buy shares in the company.

1. Strong growth rate in revenue and merchants

Ursillo says that he wants to see how fast Square’s revenue is growing along with the number of merchants using Square’s mobile payments technology. The details, he explains, will show whether Square is a fast-growing and successful business or is struggling. We won’t know exact revenue numbers until the public IPO filing is released. But Square’s revenue is growing three to four times faster than payments giant PayPal, according to one source close to the company. If correct, that means Square’s revenue is growing at least 50% year-over-year. In terms of merchants, Square has only said that it has millions of merchants. But we don’t know how many of them are actively using its payments technology on a daily or monthly basis. And we don’t know whether the number of merchants is growing year-over-year, a sign of whether its products are gaining momentum or losing steam.

2. Margins

Ursillo wants to know Square’s burn rate, or how fast it is spending its cash. It’s an important metric that shows whether a company is salting away money after it pays its bills, employee salaries, and other operating expenses. Investors will, of course, also want to see if the company is profitable. Last year, a Wall Street Journal report said that Square had huge losses—roughly $100 million in 2013 alone—and that they were growing. Additionally, the Journal said that Square’s profit margins, another important metric, were shrinking. Square denied this report, and Fortune learned from internal documents last year that Square’s margins are a healthy 34%. On a $100 transaction, the company takes a cut of about $3, which it records as revenue and from which it earns about $1 in gross profit. In 2014, the company processed about $30 billion in transactions, which would put its gross profit at an annual rate of about $300 million.

3. Are insiders selling their shares?

Investors will be looking to see how many shares executives, employees, and investors will sell as part of the IPO. In particular, all eyes will be on whether Dorsey and his top managers are cashing in. “It shows the confidence level of the leadership team in the company,” Ursillo said. Investors will also be looking at whether senior leaders sold shares privately prior to the IPO.

4. Business vs. consumer strategy

Increasingly, Square is focusing on selling merchants paid services like analytics, payroll, and cash advances. But the company also has a few consumer businesses tacked on. For example, Square Cash lets people send money to each other using a mobile app, while Caviar, another unit within the company, is a food delivery service. One question on Ursillo’s mind is how these consumer businesses fit into the company’s core payments business. Do they feed off of each other in terms of attracting customers? And how does the consumer business plan to make money? For example, Square Cash’s consumer app doesn’t charge users fees to send money. Meanwhile, food delivery is a space crowded with competitors like GrubHub, Door Dash, and Postmates, and therefore may have trouble growing.

5. The management team. Earlier this week, Dorsey took on two jobs, permanently. In addition to being Square’s CEO, he agreed to become CEO of Twitter, the social media network he co-founded in 2006. Because of his busy schedule, he needs a talented supporting cast at both companies. There aren’t expected to be any revelations about the topic in Square’s filing. But investors will undoubtedly weigh the issue when deciding whether to buy Square’s stock. The company currently has no chief operating officer or a dedicated product chief. But on the other hand, it has some experienced leaders like Sarah Friar, the company’s chief financial officer, who previously worked at Salesforce and Goldman Sachs. Another senior leader is Françoise Brougher, a former Google executive who leads Square’s business and sales operations. “A lot of companies don’t graduate because of failed leadership,” Ursillo warned.

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