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Why Analysts Are Bullish About Square

December 14, 2015, 9:40 PM UTC
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Wall Street analysts are feeling mostly positive about payments processing company Square.

A number of investment banks that recently initiated coverage on the hot tech company after its initial public offering last month gave its shares a “buy,” “overweight,” or “outperform” rating. Meanwhile, two other firms said the stock was a “hold.”

Jefferies, one Square’s IPO underwriters, was the latest to weigh in with a report on Monday that gave the company a buy rating and forecasting a $15 per share price target. That is a bullish call considering the company’s shares (SQ) closed at $12.33 on Monday.

Why are analysts so positive? Jefferies and Goldman Sachs, which was the lead underwriter on the company’s IPO, and also has a buy rating on the stock, are both bullish on the San Francisco-based company’s strategy of selling business-services alongside its payments software and credit card reader. In addition to collecting revenue from credit card payments, Square has focused on selling additional features to merchants like invoicing, payroll, cash advances, appointment scheduling, marketing features, and slicing and dicing business data.

These services don’t just create new revenue for Square, they also act as ways for the company to retain its base of two million merchants. Yes, they are still a small part of the company’s overall business — accounting for 11.5% of sales so far this year — but the revenue they generate has more than tripled from 2014. Goldman Sachs said it expects software and data revenue to represent around 25% of total sales by 2018.

Because of the growth in these services, Goldman Sachs’ analyst note cited the potential for Square’s profit margins to increase. “We believe that [Square’s] core payments business is already over 30% margin today, and we see it gaining significant leverage in lending and software as it builds scale – and forecast 34% overall margin by 2020,” the note stated.

Goldman (GS) has a price target of $16 per share on Square in the next 12 months.

Along with the potential for revenue from business services, Jefferies also expressed confidence in Square’s management team, despite founder and CEO Jack Dorsey concurrently serving as CEO of Twitter (TWTR). “[We] believe that Square’s management team possesses deep payments, technology, and consumer industry experience,” according to Jefferies.

Many have doubted whether Dorsey can maintain the dual CEO roles of two publicly traded companies, but Square and Dorsey have tried to minimize that concern by pointing to the payments company’s deep bench of executive talent. That includes chief financial officer Sarah Friar, who worked previously at Salesforce and Goldman Sachs; Françoise Brougher, a former Google executive who leads Square’s business and sales operations; and Apple veteran Jesse Dorogusker, who runs hardware. At the time of its IPO, the company also updated its regulatory filing to say that Dorsey is putting his “full business efforts and time to the company,” despite his Twitter obligations.

Jefferies acknowledges in its report that the company still faces a competitive market that also includes established point of sale manufacturers as well as others that compete with Square’s business offerings, such as ADP for payroll. Goldman Sachs believes that Square’s next big opportunity for payments revenue will likely come from larger merchants, which could difficult because it depends on convincing these retailers to forgo legacy systems for the upstart’s.

In addition to Jefferies and Goldman Sachs, Barclays gave Square an overweight rating, J.P. Morgan put a overweight rating, and RBC gave it a outperform rating with similar share price targets.

But Deutsche Bank and Stifel put “hold” ratings on Square, signaling that some investors have concerns about the company’s future share price and business. Deutsche Bank’s note, with a $13 per share target, cited the potential consumer spending slowdown as a challenge and expressed concerns over whether Square can become profitable in the near future. The report also mentioned Dorsey’s dual CEO roles as a potential obstacle for Square.

Since its IPO on Nov. 19, Square’s shares have fluctuated between $9 per share, and $14.68 per share.

For more about Square, watch this video: