Digital Payments, Now Caffeinated

Douglas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Starbucks (NASDAQ: SBUX), which has long been a pioneer in electronic payments, recently announced that it is partnering with Square for all of its credit and debit card processing. This is but the latest step in the eventual demise of cash as technology giants including Apple (NASDAQ: AAPL), Google (NASDAQ: GOOG) and PayPal, a division of eBay (NASDAQ: EBAY), all scramble to digitize our wallets.

The Starbucks alliance represents a significant step forward for its start-up partner that will not only receive a cash infusion and national recognition, but will replace the coffee purveyor’s proprietary smartphone app moving forward. Instead, customers will be invited to use the Pay With Square app inside any of the company’s locations. Ultimately, the news should be seen as bullish for Starbucks, making it a nice medium-term holding in your core portfolio.

The Square Gets a Caffeine Jolt

The critical elements of the newly-announced partnership include a $25 million cash infusion into the small California-based startup, the appointment of Starbucks CEO Howard D. Schultz to Square’s board, and the exclusive right to process all credit and debit card transactions inside every retail location. While Square currently boasts around 75,000 merchants using its service, the bulk of these are small operations that favor the smartphone connectivity over the need for a full merchant relationship with a formal credit card processor; the company has targeted merchants that might not accept credit cards but for the service.

Square has been unwilling to disclose usage statistics of its Pay With Square app, presumably because the numbers lack the size to be compelling. Those figures are likely to dramatically change, however, when the company goes live with Starbucks. The coffee giant already processes roughly a million mobile transactions per week through its own app – the app is free to download and creates a bar code on your smartphone that is then scanned at the register.

One of the features of the Square app that will not initially be deployed is the ability of the software to identify users in close proximity that are running the app. Those users can then simply state their name to complete the payment. While this feature is not planned as a part of the initial rollout, you may soon be able to simply state your name to pay for that grande vanilla half-caff soy latte.

Alternatives

While Square is trying to muscle its way into the market, the big boys are already well down the path. Apple introduced Passbook, its digital wallet, with the release of iOS 6. The app links your purchases to the credit card stored in your iTunes account, allowing you to quickly pay for things with your iProduct. Google has developed a technology called near-field communication (NFC) that allows its digital wallet to communicate directly with a merchant’s cash register.

Apple has worked with NFC technology as well, but with the release of the iPhone 5, the company decided that the technology was not ready for commercial release. While it is hard not to feel like Apple is copping out again – similarly to how the company felt 4G LTE was not ready when it released the iPhone 4S – the technology is not yet broadly accepted. Without enough locations where NFC can be used, the specific capabilities of the phone are somewhat irrelevant.

Also competing for a spot not-in-your-wallet is PayPal through its partnership with Discover Financial Services (NYSE: DFS). PayPal is attempting to bring the convenience it has offered for online payments to the retail space by partnering with Discover to be accepted anywhere the card is accepted. This union may have obtained a small early-mover advantage, but the “gadgetiness” of the Square is likely to appeal to consumers as well. In fact, the introduction of the Square has prompted copycat options to spring up overnight.

A Cup of Your Finest Joe

While the announcement is not likely to provide a huge catalyst for Starbucks, the news is bullish for the stock because it provides positive evidence that the company is still trying to innovate – no small feat for a coffee company. Offering a healthy 1.3% dividend yield and a P/E in line with its industry average, the company is well positioned. Based on the above Starbucks is a buy at current levels.

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Mr. Ehrman has no positions in the stocks mentioned above. The Motley Fool owns shares of Apple, Google, and Starbucks and has the following options: short JAN 2013 $47.00 puts on Starbucks. Motley Fool newsletter services recommend Apple, eBay, Google, and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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