Yesterday, a short seller called Hindenburg Research published a report replete with salacious claims about Block and Cash App. I don’t own any shares in Block (NYSE: SQ) nor do I work there or plan to work there, but there is just so much about this report that is misguided and demonstrative of a lack of understanding of low income individuals’ banking needs and preferences that I felt the need to respond to it. Even more troubling in this report is the shrouded implication that Cash App’s popularity in black communities and hip hop culture corroborates Hindenburg’s overall thesis that Cash App is an enabler of criminal activity.
To start with a few softballs:
- Hindenburg states upfront that their research report is based on a “2-year investigation,” as if the fact that one spending 2 years on something is meant to give it more validity. Time means nothing. In fact, it just shows the level of Hindenburg’s ineffectiveness over said period of time. The only thing worse than having someone say how long they spent on something is when someone says “I’ve been doing this for X years and so you should listen to me.” Neither are relevant, and no we shouldn’t.
- Hindenburg states upfront that their research “involved dozens of interviews with former employees, partners, and industry experts, extensive review of regulatory and litigation records, and FOIA and public records requests.” What’s staggering about this statement is that over 2 years of research, they failed to talk to the most important stakeholder — the user. Had they spoken to a few users, they probably could have figured out that the banking needs of low income people are incredibly complex and not at all consistent with the representation they’ve created in their report. And to my earlier point, they could have saved themselves 2 years of flawed effort.
My Response to Evidence of Fraud
I’m not a Wall Street guy (anymore) and so I don’t have an opinion on Hindenburg’s assertions on how Block should interact with its equity investors. My response to this report is all about clarifying critical aspects of how one should think about low income consumers and their financial services needs. I built a company (DailyPay) and invented a product (on-demand pay) that serves this very population and so have strong opinions on how misunderstood they are. These views are entirely my own and none of it should be relied upon as investment advice.
First, the crux of Hindenburg’s short sale argument is that there are bad actors, criminals, and fraudsters who use Cash App, and that this use case has fueled user growth. Yes, I am sure there are bad people who use Cash App. Cash App is in the money business, and one usually needs money to do bad things. Now, I’m not condoning those individuals’ bad actions, but there is nothing novel about bad people using money to do bad things. In this day and age, of course, that money activity is now digital, hence Cash App.
To prove their point that Cash App growth is driven by criminal behavior, Hindenburg cites the fact that “former employees estimated that 40%-75% of accounts they reviewed were fake, involved in fraud, or were additional accounts tied to a single individual.” But the key qualifier in this statement are the words “they reviewed.” In consumer finance, the bulk of the customer support and account review process for any company is indeed actually around matters of fraud. That should be obvious, and if it’s not, think about the last time you interacted with your credit card company. Why would the Review Team at Cash App review something that didn’t look wrong? And so the fact that 40–75% of the cases reviewed were classified as problematic is a tautological truth. What one needs to know is what percentage of the overall number of accounts are being reviewed for fraud. That number is surely not 40–75%. Based on my own experience in consumer finance, my guess is it’s something like 5%. And so yes, indeed I would have thought that 40–75% of the 5% reviewed are fraudulent, i.e. 2.5% of total accounts. To say that the reviewed cases are dispositive of the entire population would be like saying “40–75% of the calls the New York Fire Department responded to resulted in a fire” and then concluding that New York City is the most flammable city on earth.
Hindenburg points to a number of examples of “unusual” account activity to support their view that Cash App has rampant fraud and that user numbers are exaggerated as such. Examples of unusual activities include account sharing, multiple users for one account, accounts having attached addresses across the country, multiple accounts for one user, etc. While I obviously don’t know the specifics of every account, I can tell you from first hand experience that this activity is not unusual — it is rather just unfortunate. Account sharing is one of the hallmark traits of the un/under-banked and for low income households. Why on earth would people need to share accounts or open multiple accounts?!, asks a hedge fund manager on Park Avenue who has never interacted with this demographic of users directly. As someone who does day in and day out, I can tell you that there are about a hundred reasons why people do these things ranging from the obvious — undocumented, banned from the US banking system due to too many overdrafts, etc — to the less obvious like a worker who wants her paycheck to go to a cousin’s account so that her alcoholic spouse can’t access the funds. I know firsthand that the lives of this demographic are profoundly complex — so much more complex than that of a hedge fund manager who has one bank account and can never imagine having to move money across multiple accounts to protect her family’s livelihood. That ain’t fraud. That’s real life.
As evidence of their thesis, Hindenburg points to the fraud levels at Cash App’s partner bank and compares them to JP Morgan and Wells Fargo. According to Hindenburg, despite JPM/Wells having 4–5x as many deposit accounts, suspect transactions at Cash App’s bank were 8x higher. This however just proves the value of Cash App. The big banks cohort all low income people into one bucket. They actually don’t want any of them as customers — bad or good actors. And so yes, the incidence of fraud at big banks is low because they have very few customers in total coming from the low income population. Said simply, the sample size is very small. Cash App serves the entire low income demographic even though it knows there’s a small portion of them that are bad actors. This is a huge opportunity if one can manage and charge appropriately to offset risk from the small percentage of bad apples.
My Response to Lack of Innovation
The other principal attack that Hindenburg makes is that Cash App is neither innovative nor disruptive in its technology, pointing specifically to the fact that instant movement of money — a key Cash App value proposition — is fairly rife. Out of all of their points in their report, this one is perhaps the most misguided. Cash App absolutely is disruptive, but not for the reasons Hindenburg points to as unimportant. The genius behind Cash App was that Block made money social. Through peer to peer transfer, one could create a “network,” similar to the network you may have on say Twitter or Facebook. In many respects, your Cash App friends were just another social network, but instead of the common interest being cats or movies, the common interest here is money. Building a network around money — that is literally the most abstract and crazy thing I’ve ever heard of, but that’s what Cash App did and is doing. Hindenburg points to feature parity across all payment apps as evidence that there is nothing differentiated about Cash App. That is such a banker/consultant way of thinking about the world — make a table and put checkmarks underneath each company that has the feature and then conclude that all the companies are all the same. Hindenburg quotes the head of Cash App when describing instant deposit, “The experience was magic and we knew it was something that people desperately needed” and disputes that. Hindenburg instead says that “instant deposit isn’t magic technology [but is an] expensive, standard offering, that ubiquitous competition offers at similar or better rates.” But what Hindenburg fails to appreciate is that the magic is not in the feature or tech….it’s in the experience that Cash App has created. All aspects of the experience — the digital interface, the simplicity, the trust, the network, all of it — work together harmoniously to create the magic, and that magic is highly unique and differentiated as an experience. Slight of hand on the street corner is a hustle you probably want to stay away from…..I mean, when’s the last time you ooohed and aahhed at 3 card monte? But when you see slight of hand is in a Las Vegas theater, complete with dramatic music and iridescent lights, I’m guessing your reaction to that experience is quite different. The magic is not just the trick. It’s the entire package.
The last thing I’ll say is this — Hindenburg implies that the frequency of references to Cash App in hip hop music is an indictment of Cash App’s integrity. Along with their paper, they released a YouTube video compilation of rappers referencing Cash App in their songs. LOOK AT THIS RAPPER WHO SAID HE WOULD USE CASH APP TO PAY A HITMAN — THIS IS EVIDENCE THAT CASH APP IS FOR CRIMINALS, writes Karen, I mean, Hindenburg. Yes, rappers rap about relevant topics in culture. And guess what? Cash App is a part of culture. Is that really that weird? In the 90s, Tupac and Biggie rapped a lot about ….money. And Cash App is money in the digital era. By the way, in Mo’ Money Mo’ Problems, does the fact that Biggie rapped “B-I-G P-O-P-P-A / No info for the DEA / Federal agents mad ’cause I’m flagrant” mean that he and all rappers are drug dealers?” By Hindenburg’s parallel logic, the answer would be yes.
Look, there are plenty of reasons why one might like or not like Block as a stock, but stock picking isn’t my area of expertise. My response here is about refuting the claims of this report based on what I know to be true about consumer financial services for the low and medium income demographic.
But on a personal note, I do hope Block stock goes up, a lot.
NOT INVESTMENT ADVICE. OPINIONS MY OWN.
