‘Brazen red flag’: Afterpay’s owner Block accused of fraud by notorious short-seller

“The acquisition is flopping. In 2022, the year Afterpay was acquired, it lost $US357 million, accelerating from 2021 losses of $US184 million.”

Hindenburg cited a Fitch Ratings report that Afterpay delinquencies through March 2022 had more than doubled to 4.1 per cent, from 1.7 per cent in June 2021. Total processing volumes also declined 4.8 per cent from the previous year.

The issue of alleged fraud has been talked about across the US industry for some time says payments veteran Grant Halverson, who heads consultancy McLean Roche.

He said the allegations might be a shock to Australian investors who exchanged $US29 billion worth of Afterpay shares for Block stock.

“I bet most don’t even know what Block does?” he said.

Block, formerly known as Square, said it intends to work with the Securities and Exchange Commission “and explore legal action against Hindenburg Research for the factually inaccurate and misleading report they shared about our Cash App business today,” the company said in a statement. “We have reviewed the full report in the context of our own data and believe it’s designed to deceive and confuse investors. We are a highly regulated public company with regular disclosures, and are confident in our products, reporting, compliance programs and controls.”

Hindenburg has targeted about 30 companies since 2020 and their shares lost about 15 per cent on average the next day, according to calculations by Bloomberg News. Six months later, the shares were down 26 per cent on average. Short sellers borrow shares, sell them, buy them back at a lower price and profit from the difference.

Hindenburg gained more prominence after its Adani report in January, which roiled stocks and bonds from all 10 Adani-related companies.

Adani owns and operates the controversial Carmichael coal mine in Queensland.

The conglomerate’s flagship Adani Enterprises has dropped 48 per cent since the report, even as the group denied Hindenburg’s allegations of accounting fraud and stock manipulation. Hindenburg’s Twitter following has doubled to surpass 500,000.

Hindenburg’s report on electric-vehicle maker Nikola Corp. in September 2020 sent the stock plunging and led to criminal charges against the company’s founder, Trevor Milton. He was convicted in October of defrauding investors.

Block’s status as a stockmarket darling had already somewhat faded. The firm’s market value peaked at almost $US130 billion in 2021, and its shares are down more than 75 per cent since August of that year. Dorsey and co-founder James McKelvey collectively sold more than $US1 billion of stock during the pandemic, Hindenburg said in the report.

Investors have long worried about Cash App as well as many of its mobile-money rivals such as PayPal’s Venmo, which have faced scrutiny in recent months as fraudsters have seized the technology to fool consumers into sending them payments. But in its research, Hindenburg alleges Cash App’s problems go deeper and can be traced back to shortcomings in compliance protocols.

Hindenburg alleged that Block was overstating the number of users of Cash App, citing an acknowledgment from the company that “certain of these accounts may share an alias identifier with one or more other transacting active accounts.”

Hindenburg demonstrated the laxness of Block’s controls by setting up accounts, and conducting transactions, in the name of Donald Trump and Elon Musk.

Investors have been on high alert for such activity ever since PayPal last year announced it closed 4.5 million accounts and lowered its forecast for new customers after finding “bad actors” were taking advantage of its incentives and rewards programs. The company abandoned a long-term goal for increasing the number of new users on its platform and now focuses on enticing existing customers to use it more.

Interchange fees

The short seller also took aim at Block’s collection of so-called interchange fees, which banks collect from merchants each time a consumer swipes a debit card at checkout. That’s one of the key revenue drivers for Cash App, which has an accompanying debit card provided by Sutton Bank.

But big banks have taken aim at large tech companies partnering up with tiny regional lenders for such a business. That’s because Congress has capped what banks such as JPMorgan and Bank of America Corp. can charge for those swipes, while smaller banks aren’t subject to the same rules.

Hindenburg noted that PayPal has disclosed that it’s under investigation by the SEC for the practice, though it has no proof that Block faces a similar query.

‘Good value’

“We view the stock as good value, but are concerned with the prevalence of any criminal activity and how this could impact investor sentiment,” Robert W. Baird & Co. analysts David Koning and Robert Bamberger said in a note to clients about the Hindenburg report. “It’s hard to know exactly what impact this could have, though in a pretty dire case, if they shed 20 per cent of accounts, it could be about 8 per cent of total gross profit impact.”

Cathie Wood’s ARK Investment Management holds 1.66 per cent in Block, according to data compiled by Bloomberg, with the exchange-traded fund buying shares as recently as yesterday. The stock is also the flagship ARK Innovation ETF’s fifth-biggest holding on a weighting basis.

Loading

This is not the first time Block has been accused of misleading investors. Last year, a Block shareholder filed a complaint against the company, accusing it of waiting several months to disclose that an ex-employee took customers’ names and brokerage information. The disclosure sent share prices plunging.

Stock owner Donna Esposito specifically accused both Dorsey and chief financial officer Amrita Ahuja of participating in issuing misleading press releases and SEC filings.

With Bloomberg