Block shares tumble on Hindenburg’s short report: Citi and Morgan Stanley assess the damage

Fri 24 Mar 23, 10:57am (AEST)
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Key Points

  • Block was hit by a Hindenburg Research note titled "How Inflated User Metrics and “Frictionless” Fraud Facilitation Enabled Insiders To Cash Out Over $1 Billion"
  • Block stands by its products and compliance programs, plans to take legal action over the allegedly misleading report
  • Citi raises important questions about Cash App fraud/KYC controls and their growth profile, revenue retention, and user engagement in light of the report

Block (ASX: SQ2) shares tumbled 14.8% on Wall Street after Hindenburg Research published a report flagging fraudulent accounts, inflated user counts and prohibited user activity, among other things. 

In response, Block said its stands by its products and compliance programs, and plans to pursue legal action over the allegedly misleading report. 

“Inflated User Metrics and Friction-less Fraud”

Hindenburg posted a 17,500 word online report following a two-year investigation which concluded that “Block’s business has not been disruptive innovation, but rather a company’s willingness to facilitate fraud against consumers and the government, avoid regulation, dress up predatory loans and fees as revolutionary technology.” 

Here are some of the key highlights from the report:

  • On valuation: Even without the report, Hindenburg says the stock trades at a 2023 forward PE ratio of 40 times while competitors like Paypal trade at just 16 times

  • On crime: “Cash App takes a leading role in supporting criminals involved in human trafficking, according to the Polaris Project, a leading non-profit organisation that tracks and combats human trafficking and sex exploitation in the U.S.”

  • On users: A former employee said that 60-70% of the time, Cash App accounts will have a dozen or more account connections, with those connections counted as individual users

  • On compliance: Hindenburg said they were easily about to change their account numbers to ones that don’t match the names provided whey they created their accounts. With a fake Donald Trump account, they also promptly received a Donald J Trump Visa Cash App Card in the mail.

  • On verification: The report claims that until recently, Block failed to collect full user social security numbers when it was a Federal requirement to do so.

  • On insider selling: Block CEO Jack Dorsey and Co-founder Jim Mckelvey offloaded more than $1bn in shares between March 2020 and December 2021, with 25 transactions taking place near the stocks all-time highs. 

Brokers run the ruler: Citi and Morgan Stanley

Just like any other financial institution, Block does not have the ability to control how people use their money. However, Citi raises two important lines of questioning: 

  1. Are Cash App fraud/KYC controls up to both regulatory and industry standards?

  2. If not, are Cash App’s growth profile, revenue retention and user engagement the result of a mass user perception that the platform has inadequate fraud/KYC controls?

Citi says the company’s plans to work with the SEC and explore legal action against the writers may be viewed as “inadequate from an investor standpoint as questions remain around several focal points for Block.” 

This included issues such as:

  • Would black-listed accounts be permitted to re-enter the platform

  • Are active users/account metric disclosures accurate

  • Has disclosure increased on Cash App marketing expenses related to fraudulent activity

All that said, Citi retained a BUY rating with a US$90.00 target price. Block shares closed at US$61.88 overnight. 

Morgan Stanley was a little more reserved, with an EQUAL-WEIGHT rating with a US$72.00 target price.

The broker says it’s unclear how widespread the potential fraudulent accounts might be and could lead to an eventual culling of some fake or fraudulent accounts. 

“Investors should be prepared for a potential downshift in Cash App user growth or monetisation,” the analysts said. 

SQ2 chart
US-listed Block chart (Source: TradingView)


Written By

Kerry Sun

Content Strategist

Kerry holds a Bachelor of Commerce from Monash University. He is an avid swing trader, focused on technical set ups and breakouts. Outside of writing and trading, Kerry is a big UFC fan, loves poker and training Muay Thai. Connect via LinkedIn or email.

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