Afterpay owner Block (SQ2) has become the latest company to be targeted by US short-seller Hindenburg Research, following what it says was a two-year investigation into the fintech.

Hindenburg – which drove a $100 billion selloff in Indian conglomerate Adani over allegations of stock manipulation and accounting fraud – alleges Block "obfuscates" the user numbers for its Cash App service by reporting misleading metrics which are "filled with fake and duplicate accounts".

It also accused the company of taking advantage of users with "predatory loans and fees".

Block - previously known as Square – is a mobile payments platform founded by Jack Dorsey. The company denies the claims made in the report.

Unlike Adani, which had minimal exposure to Australian investors, Block is dual listed in Australia and the US.

Data by Morningstar can reveal dozens of Australian investment funds remain exposed to Block shares, with one fund holding more than 10% of its portfolio in the stock.

What’s happened

The Hindenburg report alleges Block’s user numbers, and customer acquisition costs are misleading due to scam accounts and fake users connected to the tech giant’s “Cash App”.

In a public statement, Block called Hindenburg's report "factually inaccurate and misleading" and "designed to deceive and confuse investors". Block said it was exploring legal action against Hindenburg.

Block’s US-listed shares dropped more than 15% by the close of New York trading, and the company’s ASX-listed Chess Depository Interests (CDIs) followed suit on Friday morning, diving almost 20%.

SQ2 shares fall on short-seller report

But Morningstar senior equity analyst Brett Horn says the claims in the report are “largely anecdotal”, and while some of the issues raised could prompt a regulatory response, he says Morningstar maintains its fair value estimate and narrow-moat rating.

“Hindenburg believes the Cash App platform is being used to perpetrate criminal activity, and that the company has turned a blind eye to this fact,” he says.

“In our view, the fact that rappers reference using Cash App for fraud in their lyrics is not compelling evidence of widespread issues.”

However, Horn did reiterate that the company’s Cash App is one of the key drivers behind Morningstar’s 'Very High' uncertainty rating.

“We think the long-term economics of this business are very difficult to predict, and that a significant factor is that the regulatory framework for the P2P space is far from settled,” he says.

“To the extent that any of Hindenburg's claims are true or even perceived as potentially true by regulators, this could prompt a regulatory response.”

Short sellers profit when a stock falls. They do this by borrowing stocks that they believe are overvalued, selling them, and buying them back later at a lower price.

How exposed are Australian funds?

Hindenburg Research made global headlines earlier this year when it released findings from an investigation into Indian multi-national Adani Group

Shares in Adani more than halved in the days following the report, but the Australian market remained largely insulated from the plunge due to limited holdings among Australia-domiciled funds.

This time, however, Australian funds and investors appear much more exposed to the impact of the report—largely through Block’s ASX-listed CDIs.

Morningstar data can reveal that 56 Australian funds have a weighted exposure of more than 0.5% to Block’s ASX-listed shares—37 have an exposure greater than 1%.

And six have exposure of more than 5%, with the largest weighting sitting at almost 11%.

Hyperion’s Australian Growth Companies Fund appears the most exposed by weight to any resulting downturn in Block’s share price.

The fund, which holds a Silver Morningstar Analyst Rating, aims to invests in growth-oriented companies which pass Hyperion’s investment process. The fund is highly concentrated, holding only 15-30 stocks at any given time.

Block accounts for 10.98% of the fund portfolio by weight, making the company the second-largest single holding in the fund, alongside an 11.3% weighted stake in WiseTech Global (WTC).

The stock also makes the top five largest holdings in Hyperion’s Global Growth Companies Fund. At 6.3%, Block is the fifth largest holding in the fund, behind Microsoft, Tesla, ServiceNow and Amazon.

In its company assessment, Hyperion noted Block’s Cash App as a source competitive advantage among its fintech peers.

Among ETFs, the BetaShares Future of Payments ETF (IPAY) and BetaShares Australian Tech (ATEC) ETF hold the largest stakes by weight, at 5.0% and 4.3%, respectively.

These ETFs are designed to passively track tech-based indexes—the Nasdaq CTA Global Digital Payments Index and the S&P/ASX All Technology Index, respectively—which list Block among their largest constituents.

Why Australian funds are more exposed

The prevalence among Australian funds is partially due to Block's dual-listing, which occurred in January 2022.

As part of its takeover of ASX tech giant Afterpay, shareholders were able to elect to receive 0.375 shares in Block for every 1 share in Afterpay as either direct shares in Block’s NYSE listing, or as ASX-listed CDIs trading under the new SQ2 ticker.

Further, Morningstar associate director of manager research Michael Malseed says as part of the ASX100, Block is looked at reasonably closely by Australian equities managers.

“Afterpay was a success story on the ASX well held by growth-oriented managers before its acquisition by Block in 2022,” he adds.

“Block's ASX listing has enabled these fund managers to stay exposed to the global fintech theme.”

Hyperion was contacted regarding the Hindenburg report but declined to comment.

After falling almost 20%, Block's ASX-listed CDIs are trading at around a 40% discount to Morningstar's fair value estimate of $153.00.