Square to acquire Credit Karma’s tax business — Cash App continues to grow in importance

On Nov. 25, Square’s Cash App — the app that wants to rule all financial apps, reached an agreement to buy Credit Karma’s tax preparation service for $50m.

Users over profits

Square Cash was launched in 2013 as a way to transfer money to friends. Over the years, the app expanded its services to allow users to make payments in-store/online, receive paychecks/tax returns and buy/sell stocks and Bitcoin.

According to the Business of Apps, in 2015, Square lost money each time a Cash App user signed up. It’s your classic strategy to acquire users first and figure out how to make money later.

And make money it did… In 2016, Cash App made an average of $15 per user, which doubled to $30 by 2020. And now, Square’s looking to find complimentary services to upsell to its users.

The growing importance of Cash App

For Square, Cash App has grown to become one of its fastest and most important business units.

• Cash App’s gross profit, the profit after deducting cost of sales, grew to $385m in the third quarter of 2020 — up 212% from the year before.
• In Sept. 2019, Cash App made up ~25% of Squares revenue — growing to 68% in Sept. 2020.

At 30m users, Cash App falls just shy of competitor PayPal’s 346m users. The addition of Credit Karma’s free, DIY tax filing service is step one in its strategy to attract more users and increase the time they spend on Cash App…

Step 1: Add new service

Step 2: Attract new users

Step 3: Upsell users on other products

Rinse and repeat.

For investors… Growth doesn’t come cheap

In 2020, Square’s stock is up over 230% — benefiting from Cash App’s ease of accepting stimulus checks/unemployment benefits and the growing popularity of Bitcoin.

But like many other companies that have benefited from the pandemic, there’s a common concern amongst investors:

• Will growth fall once the world returns to normal?
• Is the stock too expensive?

Square trades at an expensive 192x price-to-earnings ratio (i.e. it costs $192 to buy $1 in Square’s earnings) compared to an average of 37x amongst 100 of the largest tech companies. Growth companies like Square aren’t cheap and they’ll need the growth to back up its price.

We’ve already seen COVID beneficiaries like Fastly ($FSLY) fall nearly 30% in October for failing to meet growth expectations. More companies that have gone up too fast during COVID could share a similar fate and Square’s doing everything it can to avoid this.