Categories Analysis, Technology

Block (SQ) shares take a nosedive on claims from Hindenburg that it facilitated fraud and misled investors

Research shows that Block overstated its genuine user counts and understated its customer acquisition costs for its Cash App platform

Shares of Block Inc. (NYSE: SQ) plunged over 17% on Thursday after a report from short-seller Hindenburg Research indicated that the company’s ‘magical’ financial technology was not so magical. Block, formerly known as Square Inc., touted its services as a frictionless way to serve the ‘unbanked and underbanked’ customers.

However, Hindenburg claimed that its two-year investigation revealed that Block’s lackadaisical approach to compliance and regulation ended up facilitating fraud and criminal activity on its Cash App platform. It also said Block misled investors with inflated metrics.

Hindenburg’s research included interviews with former employees, partners, and industry experts, detailed reviews of regulatory and litigation records, and Freedom of Information Act (FOIA) and public records requests. It said this research shows that Block overstated its genuine user counts and understated its customer acquisition costs for its Cash App platform.

There was much hype about Cash App and its potential to drive high margin growth and new product launches. However, according to former employees, an estimated 40-75% of accounts they reviewed turned out to be fake, engaging in fraud, or were multiple accounts tied to a single person.

The report states that Block’s “Wild West” approach to compliance made it easy for criminals for perpetuate identity fraud and other scams on its platform. The users caught committing fraud simply had their accounts blacklisted without them being banned. It also says that Cash App was used for committing much more serious crimes.

During the pandemic, Cash App enabled large amounts of government COVID-relief payments. The report said that within weeks of Cash App accounts receiving their first government payments, states began working on tackling fraudulent payments. Block’s lapses in compliance such as ineffective address verification made fraud easy.

Hindenburg stated that “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 Cash App lead manager Brian Grassadonia also dumped millions of dollars in stock”.

Hindenburg added that “despite this Block is valued like a profitable growth company at an EV/EBITDA multiple of 60x; a forward 2023 “adjusted” earnings multiple of 41x; and a price to tangible book ratio of 13.1x, all wildly out of line with fintech peers”.

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