Why Wall Street is so interested in Square

Square is one of the few companies truly trying to change retail payments. This may be the only chance to buy in.

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Watching a lot of the commentary and excitement last week about Square's Thursday (Nov. 19) IPO, one might think that Wall Street had never been given a shot at a retail POS investment before. The truth is that, in many of the ways that count, it hadn't.

First, there was all of the focus on Square's IPO price of $9, a steep drop from the $11 to $13 it had projected in its prospectus several months ago. Square (SQ, NYSE) ended up on Friday at $12.85. That suggests one of two scenarios. One, that Wall Street concluded "You guys were right the first time." Or two, that Square's people were being cagey, opting to low-ball its opening figure so that Wall Street would move the stock up, which would make for a more upbeat story.

But that's all minutiae compared with the real issue, which is that Wall Street wants a big slice of retail payments and it thinks a Square IPO is the best way to do that. At a glance, that makes little sense, since some of the biggest POS players have been public for years. Add to that the fact that not only is Square not a factor in the largest retailers — its systems were never designed for the likes of Macy's, Target or Costco — but it's also not a factor for the overwhelming majority of all kinds of retailers. Indeed, Square's biggest footprint is with the smallest merchants — think independent coffee shops, pizza joints and one-location apparel boutiques — which generate transaction fees barely large enough to get any interest from a major processor.

So what's the big attraction? Square's entire system is designed for a mobile, modern-day environment. It's not merely that its software is well designed, but the entire operation looks at hardware as mobile units (typically tablets, and overwhelmingly iPads).

Apple Pay is a fast growing payment option, but even Apple Pay is ringing up barely 0.05% of retail in-store transactions. Besides, from a Wall Street perspective, buying Apple stock to get a slice of Apple Pay is like buying Ford stock because you want to get a cut on the sales of door locks.

When Wall Street evaluates an IPO, it reflexively compares the new offering with existing publicly held rivals. That's the problem with Square. In any kind of meaningful sense, it has no direct competitors.

Rick Oglesby, who tracks Square as a senior analyst with payments consulting firm Double Diamond Group, has been struggling to find any company that is doing what Square is doingand little else; approximately matches Square's revenue; and has a similar number of customers of roughly the same type.

The real issue is that Square is willing to shape things up in payments — and therefore retail — and has a legion of loyal smaller retailers willing to follow it.

"There’s a tremendous amount of investment pouring into the new world of payments and trying to reinvent the model. However, the old world of payments is very well anchored and isn’t going anywhere quickly. Payments require access to the guys that have the money (the banks), and the banks don’t have a lot of incentive to blow up the existing models," Oglesby said. "Therefore, the real innovations have to happen around the core of payments, leveraging the existing system while making it better at the same time. Square, Stripe, Braintree, PayPal are all good examples of companies that are doing this. Apple Pay is another good example of a product that does this. There’s always companies trying to reinvent the core, and none have been successful so far. They remain a long-term potential threat, but the best investments are the ones that are adding value to the existing core."

EMV isn't shaking up payments, for example. It's simply extending them into a slightly more secure (if you ignore the signature part) reality. Apple Pay and Android Pay certainly seem to be shaking things up, but that's from the shopper's perspective. From the payments perspective, there's nothing to see here. Beneath the fancy Apple Pay NFC infrastructure and secure element are the same Visas and MasterCards issued by the same old banks. The plastic may be gone, but everything remains in place.

Even worse, Apple Pay charges a fee to banks on top of existing interchange fees, making its payment system slightly less efficient and profitable than using the cards directly.

NFC payments, by the way, are suddenly becoming important, but for a non-payment reason: EMV transactions are proving so incredibly slow (the shopper must leave the card in the swipe device during much of the transaction) that it is making NFC transactions seem lightning fast by comparison.

But Square is quietly making far more radical potential changes to payments. And if Wall Street wants in, Square's the only game in town.

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