Block (NYSE:SQ), parent company of online payment processor Square, has been the subject of many headlines in recent weeks, and not for the best of reasons. Accusations from a prominent short-seller (Hindenburg Research), while not necessarily proven, have attracted a lot of attention and placed pressure on SQ stock.
However, if you believe that these allegations (which have mainly to do with compliance measures at the company’s CashApp division) are the only big risk, think otherwise.
There are several other issues at hand as well. These include concerns about rising competition, as well as with the potential impact of the current economic downturn on results in the near-term.
Yet among these risks, there is one that could especially have an outsized negative impact on the company, and on the stock. What is it? Let’s find out.
A Major Risk Hiding in Plain Sight
Even if you haven’t been following Block all that closely, it’s very possible you’ve heard of the aforementioned short-seller controversy, which may cause increased scrutiny for CashApp. You may also know the competitive pressures that the company’s most well-known platforms are facing.
But besides both these potential headwinds, there’s another you may not be so aware of, and it is one of Block’s more recently-acquired fintech properties: Afterpay. In January 2022, the company closed on its acquisition of the Australia-based “buy now, pay later,” or BNPL, platform.
In hindsight, it’s clear that Block paid way too much for Afterpay. Since the deal close, other BNPL competitors, both public and private, have experienced a severe drop in valuation.
Although the impact of overpaying for Afterpay has likely been a factor in the more than 50% drop in the price of SQ stock during this time frame, it’s very possible that additional downside lies ahead related to this deal.
Increased competition and soaring interest rates have already affected BNPL companies. The next challenge for the industry may be a rise in delinquencies because of the economic slowdown.
How Afterpay Could Sink Block Further
While Block overpaid for Afterpay, so far this segment has delivered satisfactory fiscal results. The company has yet to report rising loss rates with its BNPL business. In fact, Afterpay’s credit quality has held up well despite the big climb in interest rates since early 2022.
But while this segment has been relatively resilient thus far, doesn’t mean it will continue to be throughout the year.
Even as the company remains confident that loss rates are not at risk of spiking, a lot hinges on how severe a predicted 2023 U.S. recession will end up being.
If the U.S. economy experiences a “soft landing,” Afterpay may avoid experiencing a sharp increase in its loss rate.
Still, economists like Nouriel Roubini (aka “Dr. Doom”) believe that an economic “hard landing” remains very possible. It’s unclear how the BNPL industry will hold up if there’s a severe contraction in economic activity. This nascent industry did not exist during the late 2000s “Great Recession.”
A sharp recession would undoubtedly produce materially worse results for Afterpay than management’s guidance suggests. Hence, issues related to Afterpay could drive a big drop for SQ stock down the road.
Admittedly, potential issues with Afterpay are not necessarily a concern in the immediate term. Other issues will likely be front and center, when Block next reports quarterly earnings post-market on May 4. A good example of this is the rising concerns about increased regulation of Cash App, stemming from the Hindenburg allegations.
However, this factor is something to keep in mind, in case you are tempted to buy SQ, in the event the fintech provides the market with positive surprises in its latest results and updates to guidance.
Keep in mind too that many of the recession-related risks with Afterpay apply to some degree to the company’s other segments. For instance, an economic downturn would likely affect payment volumes for its Square segment.
Bottom line: BNPL-related risks are yet another reason to sit on the sidelines with SQ stock.
SQ stock earns a D rating in Portfolio Grader.
On the date of publication, neither Louis Navellier nor the InvestorPlace Research Staff member primarily responsible for this article held (either directly or indirectly) any positions in the securities mentioned in this article.