Square’s disappointing IPO shows the risk of overvaluing tech unicorns

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FIVE years ago the odds of being able to pay with a credit card at a street stall or coffee stand in America were next to zero. Nowadays, though, cash seems slightly déclassé at hipster cafes and fancy farmers’ markets. That is thanks largely to Square, a six-year-old firm which handles credit-card payments for 2m-odd small merchants and listed in New York this week.

A private fundraising last year valued Square at roughly $6 billion. The initial public offering (IPO) priced it at $2.9 billion, down by half. The valuation sent a frisson through Silicon Valley, where there are increasing concerns that the optimistic assumptions about the growth and profitability of many “unicorns”—privately held technology firms valued at over $1 billion—are unfounded. Square, the theory runs, may be the first of a series of “down rounds”, capital-raisings that sharply reduce valuations.

Nonetheless, the IPO still leaves Square more valuable than all but the biggest of America’s banks. That is controversial, since the firm has lost $420m since 2012 and has said it intends to lose more. Sceptics dismiss it as a money pit; believers, such as Rick Oglesby of Double Diamond Group, a consultancy, see the losses as investments in growth. He notes that although losses have increased by 80% since 2012, they have shrunk from 44% of revenues to just 16% in the most recent half-year. Project those sorts of trends forward and the future looks bright.

To gratify the optimists, Square will have to prove that it can eventually make money by helping tiny businesses accept credit-card payments. Its chief executive, Jack Dorsey, who also runs Twitter, says he resolved to create Square when he realised that “my second boss (after my mother!) couldn’t accept a credit card for his art.” The banks and companies that link firms to card networks (merchant acquirers, in the payments jargon) had long ignored any vendor likely to generate less than $50,000 a year in transactions, since the expense of recruiting them tended to outweigh the income they generated. The small firms, for their part, tended to find the paperwork, costs and equipment needed to accept card payments offputting.

Square, in contrast, offers appealingly simple technology—a small “dongle” that allows anyone with a tablet computer or smartphone to swipe a card (the way most card payments are still taken in America). It is easy to sign up for and charges the merchant a flat price, typically 2.75% of each transaction, which is unusually straightforward, although not especially cheap.

There are millions more “micro-merchants” to recruit—one of the reasons for optimism about Square’s prospects. But it takes a long time to recoup the marketing costs involved, given such firms’ low turnover and high chance of going out of business, points out Karim Ahmad of Bain and Company, another consultancy. Square seems to have concluded much the same, in that it has been expanding its offerings. It provides a service to slightly bigger firms called “Square register”, which helps them keep accounts and manage inventory as well as take payments. It also recently began offering loans to its customers, which it is well placed to do given its knowledge of their finances. By the same token it has set up a division to offer help with marketing, something for which its vast database of transactions might prove useful.

Most of the profits in the card business flow to the banks that issue them, the merchant acquirers and the payment networks such as Mastercard and Visa. Square and other tech firms that are active in this area rely on the existing card network. The extra transactions they bring into the system provide additional profits for the industry’s giants. But the innovators’ knack for design and data-crunching still rattles the incumbents, which worry about losing their connection with customers and seeing their end of the business commoditised. Square’s lacklustre IPO suggests that many investors doubt it is the firm to reshape the payments industry. But there are lots of other would-be disruptors waiting in the wings.

Source : http://www.economist.com/news/finance-economics/21678792-profitless-payment-firm-goes-public-swiped?fsrc=scn/tw/te/bl/ed/squaresdisappointingiposhowstheriskofovervaluingtechunicorns

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