Tech

Tara Lachapelle is a Bloomberg Gadfly columnist covering deals. She previously wrote an M&A column for Bloomberg News.

One of the biggest questions surrounding Twitter and Square the past few months has been, how can Jack Dorsey manage to run both?  

As shares of the $10 billion social-media app and $3.2 billion payments-software business he co-founded continue to decline, investors are increasingly hoping the answer will be that he won't have to because one of them will be acquired. But so far, serious takeover offers seem to remain elusive.

For years, Twitter has been talked about as an acquisition candidate for tech leaders Facebook and Alphabet (Google's parent), media giants such as Comcast and Time Warner, and even tech-focused buyout firms like Silver Lake (although Silver Lake is said to have no interest whatsoever). All those possible buyers and no deal. Rumors swirl, nonetheless -- and perhaps not surprisingly, given how cheap it's gotten: Since Twitter listed its stock in November 2013, the value has fallen by about 40 percent.

Buying the Rumor
Square shares surged as much as 13 percent Friday after news of Visa's stake spurred deal speculation.
Source: Bloomberg

And now Square, which has only been public for a few months, is becoming the subject of similar speculation. Visa on Thursday disclosed an almost 10 percent stake in the company. Some analysts believe that this isn't just a big vote of confidence from the world's largest payments network, it also highlights Square's appeal as a takeover target. The speculation lifted Square's stock Friday back above its $9 initial public offering price, though it's still down 29 percent so far this year. Trading volume also surged for $10 call options expiring in March.

Will Square be acquired? I don't know. But here's what I can tell you.

Bears Circle Square
Short sellers quickly piled into Square after its November IPO. Its short interest is nearly seven times the average for members of the Russell 1000 Index.
Source: Markit, Bloomberg

The majority of the company's revenue comes from fees it charges sellers -- such as restaurants, stores and salons -- that use its app and gadgets. There are about two million of them. In the 12 months through September, Square processed $32.4 billion in gross payment volume, not including card payments it processed for Starbucks or its Square Cash app, which allows people to transfer money to one another. And while more than $1 billion has been sent using Square Cash, the service is free for individuals. Transaction revenue from Starbucks was $95 million in the nine months ended Sept. 30, about 11 percent of total net revenue, but Square's partnership with the coffee chain ended this year.

Here's what future revenue might look like: 

Growth Potential
According to Bloomberg Intelligence, Square's transaction volume is still only a fraction of traditional processors and 10 percent of PayPal's.
Source: Bloomberg, analysts' estimates

Square also loses money on an operating basis. While its transaction margin tops that of peers, Square's pricing power might not be sustainable as it pursues larger merchants, according to Bloomberg Intelligence analyst David Ritter. 

Visa's interest in the business isn't new either. The $167 billion credit-card company invested in its miniature rival in 2011 (amount undisclosed). It'd be an understatement to say that competition in the payments space has intensified since then. Among the public companies, which is just a slice of the fragmented market, are PayPal, Heartland Payment Systems, First Data, VeriFone Systems and Global Payments. All their stocks have lost at least 5 percent this year. For Square, analysts are split between buy and hold ratings, with target prices spanning SunTrust's $9 to Goldman Sachs's $16. 

Undervalued?
Even amid Friday's takeover speculation, Square was trading at a 30 percent discount to what analysts think it's worth, on average.
Source: Bloomberg

Square has a great ecosystem. But of all the payments providers -- and heck, all of the other big companies Google and Facebook are supposedly going to buy and never do -- why Square? Yes, a deal would probably make a ton of sense for many of these speculated suitors. And better to buy opportunistically when Square's shares are weak. But it's far from a sure thing. 

That said, it'd be a great solution for Dorsey. Now that Square isn't performing as well as a public company, maybe he'd be more open to selling. Then he could focus on Twitter, which needs the attention

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Tara Lachapelle in New York at tlachapelle@bloomberg.net

To contact the editor responsible for this story:
Beth Williams at bewilliams@bloomberg.net