Shares in NASDAQ-listed Block Inc. (NASDAQ: SQ) - formerly Square - closed down nearly 15 per cent yesterday following the release of a savage short-seller report which alleged the Afterpay owner facilitated fraud against consumers and misled investors with inflated metrics.
Written by short seller Hindenberg Research after two years of investigation, the report claims Block - dual listed on the ASX under the ticker SQ2 - ‘wildly overstated its genuine user counts and has understated its customer acquisition costs’.
Overnight, Block hit back at Hindenberg, labelling the lengthy report as ‘factually inaccurate and misleading’, but the fallout in Australia has been pronounced in early trade with Block shares down 19 per cent at the time of writing.
In addition to allegations that Block ‘obfuscates’ customer numbers for its Cash App payments platform, Hindenberg said the Jack Dorsey-founded company’s acquisition of buy-now pay-later (BNPL) giant Afterpay was ‘flopping’, citing the Australian-founded company’s ballooning losses as evidence of Block’s lack of business nous.
Hindenberg also challenged the idea that Afterpay was a ‘responsible’ financial solution for customers and that the BNPL firm ‘lures customers into extending beyond their means’.
“The “responsible” notion stands at odds with Afterpay’s origin, which was built around avoiding responsible lending and consumer protection laws in Australia, according to local media reports,” Hindenberg said, referring to a Sydney Morning Herald article with a headline claiming the fintech was ‘built on a legal loophole’.
“Afterpay does not need to perform credit checks or income verification, typically required for traditional loans, due to technicalities such as charging “fees” rather than interest and limiting the length of its loans to 8 weeks.
“With no credit checks or income verification, Afterpay lures customers into extending beyond their means.”
The short seller also called out Block’s insistence on avoiding labelling the Afterpay financial products as ‘just another form of debt’, noting that customers were slogged with expensive fees for late repayments.
“Block suggests that because Afterpay only charges fees if a payment is late that it does not “push customers into long-term debt at high interest rates.” It also refers to its late fees as being “low and capped”,” Hindenberg said.
“The reality is that Afterpay’s late fees can reach an APR [annual percentage rate] equivalent as high as 289 per cent, worse than the most punitive debt products.
“Further evidencing that Afterpay is a loan, we can turn to Block’s own financial statements, which classify Afterpay payments as loans.”
Also highlighted was the potential introduction of ‘onerous regulations’ for BNPL companies in Australia, as well as the US Treasury Department’s moves to bring companies like Afterpay into compliance with existing lending rules which could curtail loan growth for Block.
“For BNPL borrowers to have equal protections, BNPL companies like Afterpay would need to follow the same suitability/credit check procedures and reporting that credit card companies follow,” Hindenberg said.
“This would add to the administrative and compliance burdens on BNPL providers and likely significantly curtail loan growth.”
Though attention was given to subsidiary Afterpay, the majority of the report focused on Block as Hindenberg sought to discredit the idea that the company operates on ‘frictionless’ and ‘magical’ financial technology.
The ultimate conclusion of the report was that Block had ‘systemically taken advantage of demographics it claims to be helping’.
“The “magic” behind Block’s business has not been disruptive innovation, but rather the company’s willingness to facilitate fraud against consumers and the government, avoid regulation, dress up predatory loans and fees as revolutionary technology, and mislead investors with inflated metrics,” Hindenberg said.
The report claimed that Block had inflated customer numbers substantially, relying on accounts from former employees who said that 40 per cent to 70 per cent of accounts were fake, involved in fraud or additional accounts tied to a single individual.
“Core to the issue is that Block has embraced one traditionally very “underbanked” segment of the population: criminals. The company’s “Wild West” approach to compliance made it easy for bad actors to mass-create accounts for identity fraud and other scams, then extract stolen funds quickly,” Hindenberg said.
“Even when users were caught engaging in fraud or other prohibited activity, Block blacklisted the account without banning the user. A former customer service rep shared screenshots showing how blacklisted accounts were regularly associated with dozens or hundreds of other active accounts suspected of fraud.”
Block’s Cash App payments platform was also highlighted as a problem child, with Hindenberg claiming it was a hub for organised crime like sex trafficking.
“Cash App was also cited “by far” as the top app used in reported U.S. sex trafficking, according to a leading non-profit organization. Multiple Department of Justice complaints outline how Cash App has been used to facilitate sex trafficking, including sex trafficking of minors,” Hindenberg said.
“There is even a gang named after Cash App: In 2021, Baltimore authorities charged members of the “Cash App” gang with distribution of fentanyl in a West Baltimore neighborhood, according to news reports and criminal records.
“Beyond facilitating payments for criminal activity, the platform has been overrun with scam accounts and fake users, according to numerous interviews with former employees.”
Also highlighted was the ease at which ‘blacklisted users’ could hop back onto the Cash App platform after having an account banned, and how straightforward it was to create accounts with fake names like ‘Elon Musk’ or ‘Donald Trump’ to send or receive money.
Hindenberg claimed that Block and co-founders Jack Dorsey and James McKelvey benefitted from a surge in user accounts during the pandemic - citing an increase to Block’s stock of 639 per cent in the 18 months during the pandemic.
“As Block’s stock soared on the back of its facilitation of fraud, co-founders Jack Dorsey and James McKelvey collectively sold over $1 billion of stock during the pandemic. Other executives, including CFO Amrita Ahuja and the lead manager for Cash App Brian Grassadonia, also dumped millions of dollars in stock,” Hindenberg said.
The short seller also said, even before considering the research it had conducted, that Block was overvalued.
“On a purely fundamental basis, even before factoring in the findings of our investigation, we see downside of between 65 per cent to 75 per cent in Block shares. Block reported a 1 per cent year over year revenue decline and a GAAP loss of $540.7 million in 2022. Analysts have future expectations of GAAP unprofitability and the company has warned it may not be profitable,” Hindenberg highlighted.
“Despite this, Block is valued like a profitable growth company at (i) an EV/EBITDA multiple of 60x; (ii) a forward 2023 “adjusted” earnings multiple of 41x; and (iii) a price to tangible book ratio of 13.1x, all wildly out of line with fintech peers.
“In sum, we think Block has misled investors on key metrics, and embraced predatory offerings and compliance worst-practices in order to fuel growth and profit from facilitation of fraud against consumers and the government.”
Twitter co-founder Dorsey received his own section in the report too, and Hindenberg did not hold back with its criticism of the multi-billionaire, particularly taking aim at his non-traditional public presentation.
“Traditional bankers walk around in suits and ties, making them relatively easy to spot in the wild. This is a helpful feature for normal people who can then treat them with appropriate skepticism [sic], knowing that bankers often work overtime to take advantage of people, avoid regulation, and extract money from the government,” Hindenberg said.
“By comparison, Jack Dorsey cloaks himself in tie-dye t-shirts and a guru beard, all while professing to care deeply about the demographics he is taking advantage of.
“But a close look at Block shows that it has not actually changed the game—like traditional financial services companies, its key focus seems to be on dressing up predatory loans and fees as revolutionary products, avoiding regulation and embracing worst-of-breed compliance policies in order to profit from its facilitation of fraud against consumers and the government.”
Block bites back
Following the release of the Hindenberg report, Block responded in turn and called the publication ‘factually inaccurate and misleading’.
“Hindenburg is known for these types of attacks, which are designed solely to allow short sellers to profit from a declined stock price,” Block said.
“We have reviewed the full report in the context of our own data and believe it’s designed to deceive and confuse investors.
“We are a highly regulated public company with regular disclosures, and are confident in our products, reporting, compliance programs, and controls. We will not be distracted by typical short seller tactics.”
For Block, the report comes as the company is embroiled in a US class action lawsuit from shareholders, which alleges the company made ‘made materially false and misleading statements’.
Specifically, plaintiffs allege the company lacked adequate protocols restricting access to customer-sensitive information and that a former employee was able to download certain reports of subsidiary Cash App Investing containing full customer names, brokerage account numbers, brokerage portfolio value, brokerage portfolio holdings and/or stock trading activity.
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