Home Stock Market Commentary Block (NASDAQ: SQ) Shares in Trouble After Hindenburg’s Fraud Allegations – Vahid...

Block (NASDAQ: SQ) Shares in Trouble After Hindenburg’s Fraud Allegations – Vahid Karaahmetovic

Hindenburg Research announced last week that Jack Dorsey’s Block (NYSE: SQ) represents its latest short position, accusing the fintech firm of numerous criminal activities including fraud. 

Hindenburg’s report sent Block’s shares down roughly 18% last week. As a result, shares now trade only 2.5% higher year-to-date after previously outperforming the benchmark U.S. index S&P 500 on improving risk sentiment.

Block daily chart (Source: TradingView)

Among other things, the activist short seller alleged Block’s Cash App took advantage of its “unbanked” customers, who were involved in illicit activity. It also said the app’s compliance programs were flawed. 

“Our 2-year investigation has concluded that Block has systematically taken advantage of the demographics it claims to be helping,” Hindenburg said in its report. 

What is Hindenburg Alleging in Its Short Report?

During the investigation, Hindenburg said it held talks with multiple former Block employees who said internal concerns at the company were often suppressed or ignored, despite the fact that “fraud ran rampant on its platform.”

Hindenburg’s report also includes snapshots of employee messages and allegations of financial misreporting by Jack Dorsey’s firm. A number of highlights of the report were related to Block’s Cash App, a mobile payments service with 70 million annual transacting users. According to Hindenburg, 35% of the app’s revenue stems from interchange fees. 

This means that around $892 million of Cash App revenue should be capped by law, Hindenburg alleges, however, Block circumvents that cap by routing its proceeds through a small bank. This method, which previously led to a US Securities and Exchange Commission (SEC) probe, is also used by PayPal, said Hindenburg. 

“A Freedom of Information Act (FOIA) request we filed with the SEC indicates that Block may be part of a similar investigation,” the research firm said.

Hindenburg first raised concerns about Cash App during the coronavirus pandemic when the US government provided stimulus checks to qualified adults. According to the report, the Covid lockdowns put Block’s merchant services business at severe risk.

Then, Block co-founder and CEO Jack Dorsey claimed Cash App users were able to receive their government payments instantly without a bank account thanks to the app’s frictionless technology, Hindenburg wrote.  

But several weeks later, when the first round of stimulus checks was released, states were attempting to fetch back the alleged fraudulent payments. Citing several former employees, Hindenburg said Washington State demanded over $200 million back from payment processors, while Arizona tried to recover roughly half a billion dollars. 

The employees also said that pressure from management created a “pattern of disregard” at Block when it comes to for Anti-Money Laundering (AML) and Know Your Customer (KYC) regulators. 

The aim was “to grow Cash App’s user base by strategically disregarding Anti Money Laundering (AML) rules,” former employees told Hindenburg.

To test this idea, Hindenburg opened accounts in the name of former US President Donald Trump and billionaire Elon Musk. The firm then ordered a Cash Card using their fake Trump account to check whether the app’s compliance would turn up. However, the Cash Card with Donald Trump’s name “promptly arrived in the mail,” Hindenburg wrote in the report. 

According to estimates by former employees, 40% to 75% of Block accounts they reviewed were either fake, related to fraud, or were multiple accounts tied to a single person, the report said. 

In short, Hindenburg said it believes Block deceived investors by faking key metrics and used deficient compliance practices in a bid to spur growth and ultimately profit from fraudulent activities. 

Block issued a response to Hindenburg on the same day, saying it plans to cooperate with the SEC and explore taking legal steps against the activist investor for its “factually inaccurate and misleading report” regarding the Cash App. 

The tech firm said that Hindenburg is known for making such allegations, which seek to help short sellers profit from a drop in stock prices. The company alleged it believes Hindenburg’s report was designed to mislead and confuse investors, adding it remains confident in its products, compliance programs, controls, and reporting. 

“We will not be distracted by typical short seller tactics,” said Block.

Thomas Hayes, Chairman and managing member of Great Hill Capital, pointed out that the biggest problem with Block in spite of a spate of allegations is the fact that it is still a money-losing company. 

“It is a ‘shoot first, ask questions later’ stock at this point,” he said.

Strong Stock Reaction to Hindenbrug’s Report

Following Hindenburg’s report, Block’s shares lost all of their gains in 2023. The stock fell to its lowest level since October last year as investors were digesting Hindenburg’s claims.

ARK Invest, an asset management firm led by popular investor Cathie Wood, took advantage of the SQ stock price drop and acquired snapped up around 338,000 Block shares on Friday via its exchange-traded funds (ETFs).

Brokerage firms were divided when it comes to the implications of Hindenburg’s report. 

RBC Capital Markets said the report will have a negative overhang on Block’s stock for a while. Meanwhile, analysts at Jefferies said that the majority of issues Hindenburg mentioned in its report were already known, adding that the activist investor has not reviewed the accuracy of Block’s financials. 

Analysts at Atlantic Equity downgraded Block’s stock to Neutral, with a price objective of $70 per share. 

“The improvement of risk controls would reduce these fees over time, a move which could be accelerated by stakeholder pressure following Hindenburg’s report. Given the high incremental margin of these revenues, assuming a 10-30% reduction of the Instant Deposit fees, this could eliminate 10-30% of adjusted EBITDA,” analysts wrote in the downgrade note.

Summary

Block shares closed sharply lower last week to record their worst week since June. The selloff was triggered after short-seller Hindenburg Research published a report alleging Cash App inflates user statistics. While Block shares have managed to recover in recent days, the stock still trades near multi-month lows as investors digest serious allegations outlined in last week’s report.