How’s our Twitter ex co-founder doing ? Well, after ‘Adanigate’, Hindenburg Research has this time striked through the valuations of Jack Dorsey’s company, Block. It reports widespread fraud along with allegations of misleading its investors and engaging in predatory lending practices.
Section 1: The Allegations: How Inflated User Metrics Helped Insiders Cash Out $1 Billion
These are the words of Jack Dorsey during an earning call in November 2021:
Hindenburg report claimed inflated user metrics, fraud, and $1 billion insider cash out. Former employees, partners, and industry experts, as well as regulatory and litigation records, suggest a misleading valuation and unsustainable business model.
According to the Hindenburg report, Block Inc. reported a staggering 51 million monthly transacting active users (MTAU). That's even higher than Paypal's 32.6 million MTAU, which is crazy considering Paypal is a much larger company! It's like David beating Goliath in the battle of user metrics. But here's the kicker: The report alleges that 40-75% of Block Inc.'s reported accounts are fake or fraudulent, meaning the actual number of accounts may be between 12.75 and 30.6 million.Talk about a numbers game!
And if that wasn't enough, they played with their financial statements, turning a $540.7 million loss into a $613 million profit by adjusting costs.
Section 2: The Deception Behind Block
Block's stock saw a massive increase of over 639% during the pandemic due to revenue generated from fraudulent transactions and fake accounts. They've been allowing people to create accounts with just an email or phone number. What's next, using a password like "password123" as the only line of defense? Even for the cash card as per the federal legal requirement, instead of asking for a full 9-digit social security number, it was asking users for the last 4 digits until recently.
How Block Handled Fraud Cases? Laughably!
One of the Hindenburg investigators ordered a cash card under an alias to see if the Block compliance team would catch the irregularity. Instead Block promptly mailed the Donald J. Trump cashcard.
Image Credit: Hindenburg Report
When it came to handling fraud cases, Block's solution was simply to ban the account - not the user, as stated in the report. It is unbelievable that dozens of fake or scan Cash accounts were created and fully functional on behalf of famous personalities like Donald Trump, Elon Musk and even the founder Jack Dorsey. And the refund system was just too good to be true—customers could claim a delivery problem even when they had received their order, and Block would just hand over their money. Who wouldn't take advantage of that?
According to the report, Block's fraudulent antics have been taken to a whole new level during the pandemic! Dorsey tweeted that Block was ready to distribute money to customers without bank accounts just a day before the CARES Act was signed. Block opened 11 million direct deposit accounts to transfer COVID-19 relief funds to people. Sounds great, right? Wrong! They charged a fee of 0.5% to 1.75% for speedy payments, which translates to a whopping ~205% APR. Who are they? Loan sharks?
It looks like Block implicitly allowed the fraud on their Cash app by violating compliance and regulatory guidelines. Below are the compliance violations in the report's own words
Section 3: Absurd Valuation!
Block's valuation is absurdly high, despite clear signs of trouble such as declining revenue, expected future losses, and Cash App's underperformance. As per the report, even if we overlook these issues, there's still a massive 65%-75% downside risk.
And then there is non-GAAP adjustments, which have resulted in inflated claims of profitability and a valuation that's way off the charts. With an EV/EBITDA multiple of 60x and a forward P/E ratio of 40x, Block's valuation is completely out of whack compared to its peers.
Section 4: Pop Culture and Criminal Association with Block
The report quotes interesting references to pop culture and even criminal associaltions.
The company's lax approach to account verification has made it a popular choice for fraudsters and scammers.
It's become so widely known that even rapper Teejayx6 released a song about it! Also, rapper Nuke Bizzle released a music video detailing how to commit COVID relief fraud using Cash App, with the only payment provider mentioned in his indictment being none other than Cash App!
Block promoted the video for 22Gz’s song “Cash App” which described a turf war in which the artist pays hitmen through Cash App to murder his opposition, then stuffs their bodies in trash bags. The video opens with the artist showing his Cash App as he makes a ‘throat-slitting’ motion.
Image Credit: Hindenburg Report . Listen to 22Gz’s “Cash App” here.
By the way, Jack Dorsey himself took pride in how Cash App has been mentioned in more than 200 songs. But was he unaware of what the singers were saying in their songs?
Section 5: Greed Takes Center Stage?
Block's founders presented their company as a "magical" solution to the complexities of banking, promising to offer high-interest savings accounts, no-fee banking and an innovative investment platform. Investors flocked to the company, which was valued at over $1 billion after just a few years of operation. However, a closer look at the company's business practices reveals a grey story.
Jack Dorsey's casual appearance highlighted as a potential means of manipulation in the report
The report says Block used a loophole to exploit interchange fees, essentially charging merchants multiple times for the same transaction. This not only harmed merchants but also misled investors who believed that the company's revenue came from more legitimate sources.
Block's partnership with Afterpay, a popular buy-now-pay-later platform, also raised concerns. Afterpay allowed Block to show growth in its user base, while the reality was that most Afterpay customers only used the platform once and then never returned.
Another eyebrow raising act committed by Block's founders was their decision to cash out their shares before the company's true financial situation became public. They did this by selling their shares to a Softbank-backed fund at a valuation that was much higher than what the company was worth.
Our Take on Report
The Hindenburg report on Block definitely highlights some accurate allegations regarding the company's governance, regulatory compliance, and creative accounting, which are not totally new to the public. Forbes published articles in November 2020 and January 2021 communicating concerns about Block's business model, governance and regulatory compliance.
The report shows that the BNPL model targets unbanked and underserved people with poor credit and charges high interest rates for delayed payments. We believe that people are already aware of the BNPL model. We also covered a similar story of the Chinese education loan scam highlighted in our previous report RBI: A Game of Bans!
The report also highlights Cash App as a major source of Covid-19 fraud, but partner banks are also responsible for due diligence. It's unclear if Cash App was the only means of accessing the funds, as ATMs, bank branches, credit cards, and other money transfer services accounted for most of the transactions. Money transfers or funds transfer services including Cash App accounted for only 7% of the total or about 12% of the cashed-out funds.
The report criticizes Jack Dorsey personally which seems irrelevant to the allegations against Block. Block has never been profitable on a GAAP basis and relies on non-GAAP metrics to inflate its valuations, so investors who rely solely on non-GAAP metrics are doing so at their own risk. Despite the red flags, Block's stock price has fallen by 15% - 17% compared to Adani's 48% drop.
We think the market has already processed the Hindenburg report. Block Inc. saw a 15% decline after the report got published but now has recovered. As of today, Block gained 3.72% from its last closing and 5.92% from its lowest on 23 Mar, 2023. What remains to see is how regulatory and financial bodies of the US will respond to the Hindenburg report and what will be the course of action from Jack Dorsey and Block Inc. Will they sue or not remains the question?