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Three Tough Questions Square Will Face During Its IPO Roadshow

It's getting hot in here.

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Jason Del Rey has been a business journalist for 15 years and has covered Amazon, Walmart, and the e-commerce industry for the last decade. He was a senior correspondent at Vox.

After announcing its initial IPO price range last week, Square’s executive team will meet with investors during its roadshow, which starts this week in San Francisco, New York and Boston and continues next week in a few more cities. The point of the roadshow is to drum up investor interest as well as answer any nagging questions potential investors may have ahead of the big event.

Based on my conversations with public-market investors and my own knowledge of the company, here are three major questions that are likely to come up. A Square spokesman declined to comment, citing the company’s pre-IPO quiet period.

What’s the plan to get to profitability?

From a GAAP perspective, Square is as far from profitability as my Knicks are from an NBA championship. The company lost $131.5 million on $892.8 million in revenue in the first nine months of the year.

But as many companies do, Square will be able to get analysts and investors to pay more attention to its made-up adjusted Ebitda metric: That is, the company’s profit when you strip out a whole bunch of expenses — including the entirety of its soon-to-end Starbucks processing deal — that the company says do not reflect the health of its core business operations.

But even using this company-friendly metric, you have to squint pretty hard to see Square’s path to profitability right now. In the first quarter of this year, Square lost $20.1 million using this metric. In the second quarter, it bumped up into the black, with adjusted Ebitda of around $859,000. Some viewed this as a signal that the business was trending in a direction toward profitability. But in the third quarter, Square’s adjusted Ebitda number slid back into the red, with the company losing $15.8 million using the favorable metric.

So what might Square’s spin be?

First, I’d imagine investors should expect to hear some phrasing that Amazon has made popular. From Square’s S-1 filing: “We frequently make decisions that may reduce our short-term operating results if we believe those decisions will improve the experiences of our sellers, their customers, and other users of our products and services, which we believe will improve our operating results over the long term.”

Translation: “We will continue to lose money now if we think it will benefit everyone later.” That may be a hard sell.

“You gotta have the pixie dust to be able to pull it off,” said one investor in public companies. “It’s got to be earned over time.”

I’d also guess Square will talk through the specifics of how it will eventually make money on its core payments business, which typically carries mediocre gross margins. In its IPO filing, Square says it takes on average a year to 15 months to break even on a new customer, factoring in the sales and marketing costs that went into acquiring that customer.

The filing also indicates that revenue from Square’s existing payments customers is growing about 10 percent a year (Square described it this way: “Over the past four quarters, retention of transaction revenue net of transaction costs for our cohorts has, on average, exceeded 110% year-over-year”). But that also suggests the majority of Square’s revenue growth is coming mainly from new customers and new products.

I’d guess Square placed the previous two facts together in the filing because the company is trying to suggest that after it breaks even on a merchant around one year in, it will be able to pocket most of that 10 percent revenue growth as profit going forward. But it doesn’t say that outright.

I’d also imagine Square will point to its new, more profitable business lines when answering this question. This other unit — dubbed the data and software products business — includes Square’s fast-growing cash advance business, its marketing and payroll software tools and its Caviar restaurant-delivery business.

In the first half of the year, this group boasted gross margins of 65 percent compared with around 36 percent for its main payments processing business. It only made up 11 percent of Square’s adjusted revenue during that period (excluding Square’s revenue from the Starbucks deal), but I’d expect the company will present the case that it will be a big part of the business in the future, which will go a long way toward giving Square a shot at profitability.

Speaking of which, can Square really differentiate itself from other payments companies?

Square and Dorsey scoff at the label “payments company.” Square prefers to say that it is building a “cohesive commerce ecosystem.”

That’s not surprising. Payments processing is increasingly viewed as a commodity service with many companies competing on price and that’s about it. So Square has been selling itself in recent years as a company that aims to give businesses a wide range of software products to grow their business, attract new customers and keep their current ones happy.

This is not a new approach. Intuit has been talking for years about building the operating system for small businesses. PayPal has also attempted to build tools around the core transaction. Some investors have not been impressed.

“Certainly if you go off the last four or five years, it would prudent to be skeptical,” said Brad Slingerland, portfolio manager for Global Technology funds at Janus Capital Group. “Why have other really smart and well-funded startups and established companies failed despite their best efforts to pull that off? We’re interested in the answer to that question.”

How will Jack Dorsey handle two CEO gigs?

We’ve talked about this before, and we’ll talk about it again. There’s going to be a certain segment of investors who aren’t comfortable with a CEO leading two public companies, both of which still with much left to prove. When Dorsey gets this question this week, I’d imagine he will point to what he considers a strong supporting cast at both companies, including COO Adam Bain at Twitter and a stable of talented execs at Square, which just got a boost with the hiring of former Yahoo executive Jackie Reses.

But there’s a reason you can count the number of top CEOs who’ve led two major companies at the same time on only two fingers (Jobs and Musk): It takes the rarest of leaders to make it work. A lot of people who know Dorsey believe he has grown into that kind of leader, but the results will speak for themselves.

Public market investors who spoke to Re/code were hesitant to go so far as to say that Square’s stock will trade with a “Jack discount” but did say it definitely creates another layer of scrutiny on Dorsey.

“It’s certainly a recipe for a potential problem,” said one.

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