Afterpay’s new owner, Block, has been accused of facilitating fraud

Sascha: [00:00:04] I'm Sascha Kelly and welcome to The Dive, the podcast that asks, Who has said that business news needs to be your business. Today we're talking about Afterpay, the definition of an Aussie success story. Regardless of your personal feelings of the product, I imagine you're familiar with it. It was all over the mirrors when I went shopping on the weekend. It's hard to escape. Here's a reminder. It's the buy Now pay later service that catapulted to the front of the pack when we had that wave of fintechs that came through a couple of years ago. And if you're reading financial media every day like we are, you're always encountering that headline. This stock is the next Afterpay. It just reminds us of what a golden run it had during the pandemic. Afterpay became so successful that it was acquired for a tidy 29 billion USD in 2021 by block, formerly known as Square. One of the hottest fintech companies listed in the States.

Audio Clip: [00:01:04] Shares of Square are up more than 11% today. On the back of that news, Afterpay in Australia also up double digits. 

Sascha: [00:01:11] And this is where our conversation goes today. Block, Afterpay's parent company has found itself in some hot water. Last week, it was targeted by one of the most feared activist short sellers in the world, Hindenburg research. And as a result, the share price took a dive. It's Wednesday, the 29th of March. And today I want to know what do companies do and how they respond to short selling reports? To talk about this today, I'm joined by my colleague here at Equity Mates. It's Darcy Cordell. Darcy, welcome to The Dive. 

Darcy: [00:01:48] Hello, Sascha. Thank you. 

Sascha: [00:01:49] Look right up the top. We are talking about Afterpay's parent company, Block. Is Afterpay itself accused of doing anything? 

Darcy: [00:01:57] In short, it's not Sascha. This is isolated to other parts of Block's business. However, Hindenburg did have a bit of a dig at Afterpay, saying that it was designed in a way that avoided responsible lending rules, and it extended a form of credit to users without income verification or credit checks. So a little bit of a drive by, but nothing illegal from Afterpay. 

Sascha: [00:02:19] Those are well-worn criticisms. It's not the first time I've heard it, but as you said, it's not illegal. So let's turn to the allegations against the parent company, Block What a Hindenburg saying. 

Darcy: [00:02:31] Block has a few arms to its business, and one of those is called Cash App. Basically, it's attempting to take on the big banks by offering savings accounts and loans and access to equities and Bitcoin investing. Now, Hindenburg said cash app was being used to pay for sex trafficking and drugs. It outlined how users in the hip hop community boasted about how easy it was to facilitate crime on the platform because Block allowed blacklisted users to stay on the app. Hindenburg also alleged that Cash app was likely facilitating scammers who were taking advantage of the US government stimulus programs during the pandemic. It also alleges the business is working its way around US regulation to overcharge retailers using block square point of sale terminals. And really overall Hindenburg claims the fintech has been overrun with scam accounts and fake users, meaning that it overstates its user numbers to investors. 

Sascha: [00:03:28] That's an interesting point. So what kind of numbers are they accusing Block of in terms of fake accounts? 

Darcy: [00:03:35] So in its most recent results, Block said it had 80 million annual transacting actives and 51 million monthly transacting actives. But the report said these numbers are misleading and it cited a former employee saying that it was common to see cash app accounts with a dozen or more account connections, which inflates those figures. 

Sascha: [00:03:57] So basically the one user having several different accounts and those counting as different individuals. 

Darcy: [00:04:05] Yeah, that's right. So Hindenburg has called for the company to report on how many unique people actually use cash app. 

Sascha: [00:04:11] So that was in Hindenburg's original report that they released. I want to know what happened when that report landed. 

Darcy: [00:04:19] Yeah. So the stock, which is listed in both the US and Australia, it fell as much as 22% on the day the report was released and CEO Jack Dorsey had more than $500 million wiped from his net worth in a single day. Block, it's actually recovered quite strongly since the stock has, but it's still about 10% below what it was before this report was released. 

Sascha: [00:04:42] Hindenburg is a name that we've talked about before. Darcy, Can we get a quick recap on who else they've targeted? Because earlier in February we did do an episode on their investigation of Adani. That was fascinating. 

Darcy: [00:04:55] Hindenburg has become one of the most feared activist short sellers in the world.

Audio Clip: [00:04:59] Hindenburg is a name that our audience clearly knows because of the world. They've done names like Adani and Nikola, the Electric Vehicle company. But over the last two years, since 2020, when Bloomberg's analyse what Hindenburg's done, they have published reports in about 30 names. Those stocks have taken a beating on the day of the report, but six months later have still remained lower than that mark. So there's at least some validity to the fact that investors take these reports seriously. 

Darcy: [00:05:25] As you said earlier this year, it targeted Indian conglomerate the Adani Group, in what it called the biggest fraud in corporate history. That report itself, what 100 billion USD from the value of various Adani related companies. 

Sascha: [00:05:39] And I'm going to link that in the show notes. So there's one thing you've got to say. Darcy, they know how to write a phrase. They really go for these companies with great eye-catching titles. 

Darcy: [00:05:49] They love a headline, don't they? And Hindenburg also famously went after electric car maker Nikola back in 2020. They claimed that its promises of delivering electric vehicles were basically an intricate fraud. And the fallout from that was that Nicholas found a Trevor. Milton resigned from his role as CEO, but now says that we've got this new report into block, which Hindenburg says is the product of a two year investigation. 

Sascha: [00:06:17] They certainly do spend a lot of time on these reports. I think it was a similar amount of time that they'd spent on the Adani report as well. Interestingly, Darcy, Hindenburg isn't the only one with this approach. This activist short seller business model is becoming more common. Essentially, they find companies that they believe are fraudulent or overvalued and take a short position in their stock, which is basically where you make money if the share price falls and then the release of report, as Hindenburg have done with Block and Adani. And in this report, they present their evidence as to why they think the company is fraudulent, overvalued or just bad.

Darcy: [00:06:58] Yeah, and they're certainly not the only company that does it. Sacha There's some other famous short sellers, including Muddy Waters. There's Citron Research and Konica Associates. There's actually a good Netflix doco called The China Hustle, which looks at short sellers exposing some fraudulent companies and activity in China. Worth a watch.

Sascha: [00:07:17] Okay, Darcy, I want to talk about what exactly a company does when a report like this gets released. And it's all about them. As we heard, it's pretty devastating for their share price. So you've got to respond, right? Let's see what blocked it in just a moment. Welcome back to The Dive, where business news definitely isn't all business. That's our promise to you in exchange. Here's a little something you can do for us. Jump on your podcast player and give us a five star review. Makes all the difference. Today, though, we're talking about a new short report by Hindenburg Research, which is accusing Afterpay's parent company bloc of facilitating crime and lying about the number of users. Pretty strong words. Hey, Darcy. So how did Block go about responding to these accusations? 

Darcy: [00:08:09] They're not happy and they vowed to defend themselves. Block does say Hindenburg is known for these types of attacks, and they're really designed solely to allow short sellers to profit from the falling stock price. 

Audio Clip: [00:08:22] Getting back to those headlines from Block responding to Hindenburg research, we are now getting the full statement here where Block says, We intend to work with the SEC and explore legal action against Hindenburg research for the factually inaccurate and misleading report they shared about our Cash app business today. 

Sascha: [00:08:38] I mean, I could have probably guessed that they weren't going to be Darcy, But aside from, like, releasing a really public statement and outlining what you just said, are there any other kind of options that they have on the table? 

Darcy: [00:08:50] You really have three options when it comes to responding to short sellers. You can fight the battle in the media and try to win public opinion and support. 

Sascha: [00:08:59] Okay, who's tried to do that?

Darcy: [00:09:00] Interestingly, back in 2015, US pharmaceutical company Valiant was absolutely flying. It was up more than 4,000% in a couple of years. And the stock market and its CEO was really popular, but then it was accused of sketchy accounting and some other unethical practices by a group of short sellers, Sascha. Bill Ackman, one of the most influential hedge fund managers in the world. He was one of the largest shareholders at Valiant and he actually compared CEO Michael Pearson to Warren Buffett after these short sellers went public. So they went all in on the public opinion and support, but it actually didn't end very well for them. It turned out that a lot of these allegations were true and the stock ended up crashing more than 99%. It's no longer listed.

Sascha: [00:09:47] Okay. So the lesson there seems to be only go with public opinion if it's not true. What about the second option? 

Darcy: [00:09:56] The second option is to fight the short sellers in the courts. And that's what Bloch says it's going to do. There is a pretty wild story of this happening in the past as well, and it's with the CEO of Medics, which was another US biopharmaceutical company, and he fought back against what he called a wolf pack of short sellers who targeted the company back in 2017. He said that they made fraudulent and unethical accusations and launched a lawsuit against three short sellers. One of those short sellers, Marc Holders, ended up bringing forward a defamation lawsuit against the CEO for calling them a Wolfpack. And he alleges that the CEO hired people to spy on him and dig up dirt on him, basically to ruin his reputation. 

Sascha: [00:10:43] Also, I remember that fighting short sellers in the courts is what Adani said they'd do. Yeah. Has anything happened?

Darcy: [00:10:49] That's absolutely right. We haven't seen anything brought forward yet. But they do say that they'll be bringing forward a court case. 

Sascha: [00:10:55] Okay. And so I guess the final option is just to do what I do best, which is ignore the problem. No, that's a joke. But I'm imagining they're just going to ignore the short sellers and hope the problem goes away. 

Darcy: [00:11:07] Well, that is the final option. Just try to prove them wrong over time. Australian software company Ys Tech, that was the subject of a scathing report by research firm J Capital in 2017 who accused the company of accounting trickery to inflate their growth. They called it the biggest accounting headache they've ever had. At the time, Sascha Wise Tech was trading at $35 on the stock market, and when the report was released, it plummeted down to about $30. But fast forward to today and Wisetech is a massive Australian success story. CEO Richard White is well respected and the stock trades at nearly $65. So why is Tech barely responded to their pullback then? They just went on with their business and eventually proved them wrong. 

Sascha: [00:11:53] A class act, if you ask me, Darcy. So at this stage we don't know if Hindenburg is correct, but let's just assume for the sake of this exercise that they are. How bad would that be for Block? 

Darcy: [00:12:06] Yeah, this is a bit of a tough one, Sascha, lot of analysts have come out saying they don't think the accusations are actually very strong against block And there haven't been any other investigations opened in to block or cashed up yet. And Block have said that they'll work with the SEC to clear their name, But this report could have an impact on Block's plans to launch Cash app in Australia and other countries. Morningstar analyst Brett Horn said he thinks the short report is quite weak, but he is concerned about how. It could shape the incomplete regulatory regime around peer to peer payment providers like Cashapp in Australia. 

Sascha: [00:12:42] Interesting. Darcy Well, as you said, Block's share price has recovered pretty well since, but it sounds like there will be definite impacts on how they're rolling out their products in different companies in different jurisdictions as a result of this report. I find short selling reports and these stories some of the most fascinating in business. So I'm really glad that we got the chance to talk about it today. Remember, you can be part of the conversation to let us know what you think. If you're listening in the Spotify app or you can contact us by email thedive@equitymates.com or come and follow us on social media. All those links in the show notes below. The best thing, the absolute best thing that you can do for us at The Dive is send us on to a friend who you think will enjoy it. We would love to get your help getting in front of other ears. So for to write a lovely message, tell a friend to give us a listen. Give us a try. Huge thanks to you, Darcy, today for joining me and talking about this topic.

Darcy: [00:13:41] Thanks, Sascha. 

Sascha: [00:13:42] Until next time.