Forget Twitter, Buy Square in 2014

Forget Twitter, Buy Square in 2014

With all of the hype last week surrounding the Twitter IPO, which is beginning to show shades of the disastrous Facebook IPO of 2012, most investors probably missed the news that a second company founded by entrepreneur Jack Dorsey is planning to go public in 2014.

The company
Square, a mobile payments company founded in 2009 by Dorsey and Jim McKelvey, is revolutionizing the way that consumers and merchants process payments on the go. The company's two main products are Square Register and Square Wallet.

Square Register is a service that merchants use to accept credit and debit card payments from consumers. The process works by either manually entering the consumer's card data via the app's interface or by swiping the consumer's physical card through the Square Reader, a tiny plastic device that conveniently plugs into mobile phones and tablets running either Google's Android system or Apple's iOS.

Register has really taken off with small businesses as the service provides a safe, secure, and convenient way to process payments. The merchant is charged a flat fee of 2.75% per swipe on all major credit cards, and the proceeds are transferred to the linked bank account within 1-2 business days.

The company's Wallet service allows customers of select stores to purchase products simply by checking in and providing their name to a sales associate. The merchant then verifies the customer's ID and his or her card account is charged automatically. Square aggregates all of the consumer's credit cards, loyalty cards, and receipts, making for a convenient way to shop securely simply by providing a name at the point of sale.

The growth opportunities
The largest driver of future growth for Square will be the continued expansion of its two main services across the world. The more merchants there are that accept the service at the point of sale will in turn increase the adoption of the company's services among consumers.

The good news is that the opportunities for Square's payment services are not yet anywhere close to being fully realized. At the beginning of 2013, COO Keith Rabois announced that Square had reached 3 million users. Although certainly impressive for a company that had only 1 million users the prior year, it pales in comparison to the 180 million-plus Americans that carry credit cards.

The better news is that the company's website shows only the United States, Canada and Japan as current markets. This means that the rest of the world has yet to be tapped.

Even if Square manages to tap into a significant portion of the world's card users, that number is still growing at a rapid rate each year. It was recently estimated by MasterCard CEO Ajay Banga that 50% of consumers in America and 80% of those around the world still use cash and checks to make payments, meaning that the transition to plastic is still in a relatively early phase stage.

The combination of an increasing number of credit card users around the world and Square's still small geographic footprint means that explosive growth for the payments company is almost assuredly on the horizon.

What's different?
Obviously, Square will draw comparison to two of the more notable IPO's in recent years, Facebook and Twitter. The comparisons may be more common with the latter since the companies share a co-founder in Jack Dorsey. However, one of the more crucial differences will almost undoubtedly come down to size.

When Facebook shares began trading on the Nasdaq on May 18, 2012, the company was valued at a ridiculous market capitalization of over $100 billion. That number had grown quickly in the days before IPO as investors with early access began buying shares closer to the $50 billion market cap range. Similarly, Twitter was expected to make its IPO with a market capitalization of $10-$15 billion, but began trading publicly on the NYSE last week with a market capitalization closer to $25 billion.

Not surprisingly, investors who bought stock in either Facebook or Twitter on day one did not do well in the early days of trading. What happens down the road is a different story, but it is evident that hype definitely inflated the valuations of both companies to the detriment of retail investors. What investors will need to monitor with Square's expected IPO is the amount of hype that leads into the first day of trading and its affect on the company's size.

I would bet that since Square is very much under the radar for most investors, it will not initially trade at a ridiculous market cap valuation. The company has a small user count of approximately 3 million, as compared to Facebook's 1 billion and Twitter's 230 million. The company was valued at $3.25 billion in 2012 and is expected to do $1 billion in sales in 2014. If retail investors can get anywhere close to that valuation, Square looks enticing.

Another major difference is the type of business Square engages in. While certainly not as flashy as the aforementioned social media darlings, Square's services fill a void for small business owners that want to conveniently accept credit and debit cards while avoiding complicated fee structures. The utilitarian nature of Square's business is preferable to the businesses of social media sites that are dependent on capturing ad revenue derived from web traffic.

Here's one last thing to think about: both Visa and Starbucks have reportedly invested money in Square over the years. Investors should probably consider doing the same when given the chance in 2014!

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Philip Saglimbeni has no position in any stocks mentioned. The Motley Fool recommends Facebook. The Motley Fool owns shares of Facebook. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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