Author | JR Research

Compilation | American Stock Research Society

Hindenburg Research recently beat Adani Group, led by Indian billionaire Gautam Adani, and found a new acquisition target.

Founder Nathan Anderson is keen on "discovering scams". For the latest goal, Anderson's company released a report on$Block (SQ.US)$The short report ended a two-year investigation.

Accordingly, Hindenburg accused the company led by Jack Dorsey of contributing to the following actions:

Deceive consumers and officials, evade regulation, mislead investors, and disguise predatory loans and fees as revolutionary technologies. -Block Hindenburg Research report

Hindenburg's short report caused Block shares to fall nearly 20 per cent in pre-market trading. However, as low-priced buyers entered the market to fend off the attack on Hindenburg, the stock has rebounded, easing pre-opening losses.

Hindenburg's main objectives in the report are related to its cash application. Savvy investors should know that Block's Cash App is a key growth driver for the company, growing significantly during the outbreak.

Despite a slowdown in 2022, its revenue grew 51 per cent year-on-year in the fourth quarter of 22 (excluding Bitcoin and Afterpay). As a result, it easily overtook Square, INC. 's division, whose revenues were up 10 per cent year-on-year (excluding Afterpay).

So Hindenburg's focus on Cash App is justified, as analysts see it as a key growth driver for the company to maintain its growth valuation.

Morningstar stressed in the report, "compared with its peers, Cash App's performance is relatively strong, which shows that it positions itself as a long-term leader in this field."

However, Hindenburg believes that Cash App growth has been grossly exaggerated. The research institute emphasizes:

Block's Cash App has 51 million active trading users every month, but former employees estimate that 40 per cent of the accounts they review are fake, involving fraud or additional accounts tied to a single person. -Hindenburg

If this were true, it would be an exaggeration. The number of monthly active or MTA users of Block in 2022 was 51 million, up 16% from a year earlier. However, this growth rate has slowed sharply compared with 22 per cent growth in 2021 and a surge of 50 per cent in 2020.

As a result, Hindenburg's argument is that Block "tampered" with its data to drive MTA growth and portrayed an "illusion" to drive its share price.

In addition, the company highlighted Mr Bullock's claims about "subversive" technology and the "magic" designed to deceive investors into thinking it had an important moat, but that was not the case.

To make matters worse, if Block exaggerates user metrics, as Hindenburg stresses, then Block may be grossly overrated.

Hindenburg believes that given the differences in Block's business model, reported indicators and findings, it believes that Block's trading price should be much lower, probably down "65-75 per cent" from yesterday's closing price.

That means its fair value is about $22. But for now, Morningstar does not agree with this view. Morningstar values the company at about $104.

SQ mixed fair value (InvestingPro)

InvestingPro also said the hybrid fair value was about $99. We think it's closer to $55 to $60. Therefore, there is considerable uncertainty about its fair value.

However, if we consider Morningstar's valuation, it should be clear that Cash App plays an important role, as it emphasizes:

We expect Cash App growth to be stronger and this area will become a more critical growth engine. Excluding Bitcoin revenue, we expect revenue from cash applications to grow at a compound annual growth rate of 23% over the next 10 years. Morningstar

Block regulators are likely to investigate because Hindenburg has proved its credentials to Nikola founder and hedge fund Platinum Partners in the past.

Anderson even claimed that he would not stop digging for scandals unless corporate fraud ceased to exist.

If one day I feel that most corporate fraud in the United States has been eliminated, then I may announce that I am going to grow tomatoes or something. -- New York Times

Dorsey is now his target; we think this may be just the beginning.

Warren Buffett, chief executive of Berkshire Hathaway, reminded investors in his latest annual letter that he had zero tolerance for management misconduct. He said:

Trust and rules are essential when managing large enterprises. Berkshire's emphasis on the former has reached an unusual-some would say extreme. Disappointment is inevitable. We understand business mistakes; our tolerance for personal misconduct is zero. -- Warren Buffett's annual letter 2022

Investors are advised to do the same, so while the current price looks attractive, don't buy on the bargain yet.