Description

On today’s edition of left-for-dead smid-cap growth companies that are actually okay businesses, I bring you Lightspeed Commerce (NYSE:LSPD and TSX:LSPD – will only cite NYSE / USD figures). LSPD sells cloud-based point-of-sale (PoS) terminals and integrated software to SMB restaurants and retailers around the world.

LSPD just posted 4 quarters of 50-70% organic growth, and is valued at 5.7x consensus forward gross profit. Other companies in this rarified growth range are (still) valued at 2x – 3x+ the multiple. At these levels, either the business is a fraud or is economically unviable, or you make money as LSPD continues to grow and scales its costs such that you exit at a reasonable FCF multiple.

The thesis for LSPD is: (1) many more SMBs will replace legacy PoS systems with cloud-based PoS systems; (2) LSPD will continue to be one of the winners from this trend, particularly i) overseas in markets with limited competition & ii) with SMBs that benefit from its inventory management modules; (3) as the company transitions out of hypergrowth mode, we will see operating leverage drive FCF margins in the 30’s in 5 years (as % of GP – revenue is less meaningful here because of payments accounting) and 50% in 10+ years. I pencil to 24% returns assuming teens 5-year GP CAGR (much lower than consensus estimates and historical growth, for whatever that’s worth) and a high 20’s FCF exit multiple in year 5 (translates to a teens FCF multiple after reaching full margin scale).

I suspect this opportunity exists because of the lingering stink of Spruce Point’s September 2021 short report, and of course, general high-growth unprofitable tech carnage. This one looks mispriced even if you accept the latter trend as here-to-stay.

This write-up will be structured as follows:

·         About the Business

·         Thesis

·         Spruce Point Report

·         Risks

About the Business

Lightspeed sells cloud-based PoS terminals with integrated software that you can access either on the terminal or remotely. Compared to their low-NPS, on-premise counterparts such as NCR and Oracle MICROS, modern, cloud-based PoS systems like LSPD’s integrate better with other restaurant/retailer software (e.g., accounting systems), have more helpful features (e.g., integration with food delivery services, built-in loyalty program management, syncing of sales data across locations), can be accessed remotely, break less often, and are cheaper all-in.

It’s no surprise that cloud-based systems are winning – the category got to 25% share of small U.S. Retail and Hospitality payment volumes from practically zero in ~five years (and that 25% is much lower in the rest of the world). As on-prem PoS contracts come up for renewal and newly-launched businesses seek modern solutions, these upstarts will continue to take share.

LSPD was founded in 2005 by Dax da Silva (who recently stepped back from his CEO role and became Chairman), went public in Canada in 2019, and did a U.S. dual-list and raise in late 2020. LSPD has acquired 10+ companies since founding, including foreign PoS players to help it break into new markets (e.g., German hospitality PoS player Gastrofix) and ecommerce software solutions (e.g., poor man’s Shopify, Ecwid).

The company has integrated these acquisitions into two distinct product lines that they are currently selling (and converting acquired users to): Lightspeed Retail and Lightspeed Restaurant. The former accounts for 61% of its locations and the latter 39%. Locations are split ~50-50 between N.A. and other geo’s. LSPD makes 60% of its gross profit dollars from subscription fees, and the rest from taking a cut of payments (and breaks even on selling the iPad-powered hardware itself, which is a minuscule part of revenue and GP). Payments is growing a lot faster, however, as LSPD pushes its own Stripe-powered Payments product (previously outsourced processing to Worldpay etc.) that allows it to capture more than double the net yield on TPV. This is built-in growth for LSPD as Lightspeed Payments is newer and only 12% of TPV.

Notable cloud-based competitors include SQ (U.S.-focused, both retail and restaurants, skews to smaller customers), TOST (U.S.-only, restaurants), Shift4 (payments processing, has its own PoS systems and also supports 3P), and Clover (owned by FISV).

Thesis

·         Cloud-based PoS will continue to share, with 75%+ market share among SMBs in the end state

o    Retail and restaurant chains may be tougher given the levels of customizations needed, but TOST would tell you that these are addressable as well

·         LSPD will continue to be a key beneficiary from this trend

o    Per calls with customers, the product is good and wins in specific use cases:

§  Restauranteurs in the fine dining space tend to like Lightspeed’s advanced restaurant modules like its table management tool

§  Retailers in niches with complicated inventory needs, like bike shops, like Lightspeed’s inventory management modules, which are built to simplify high SKU count needs

o    Lightspeed systems do not seem to have the win rates and adoration that SQ and TOST have. But the global market is huge, SQ and TOST do not play overseas, and LSPD continues to rank well in the aforementioned niches in all regions

·         LSPD has strong unit economics and will be profitable as it matures

o    Today, management is investing heavily in S&M (36% of sales) and R&D (21% of sales)

o    In a lower-growth state, S&M can be something like 10% of sales to support single-digit growth and existing customers, and maintenance R&D plausibly could be 15%

o    As such, I think 50% FCF as a % of GP, translating to ~20% margins on revenue, is reasonable in the long-term

§  The operating leverage for this business is intuitive – after you sell customers the terminal, which is ~breakeven, all you need to do is invest in some baseline level of ongoing R&D to keep them happy – these are very sticky systems in a slow-moving industry, as evidenced by the legacy players continuing to hold majority market share despite selling inferior solutions

§  Right now, LSPD investing heavily in a sales team to run around to SMBs and sell these terminals is the value-maximizing thing to do (clearly this line of thinking is out of favor in public markets – I agree with scrutinizing cash-burning, potentially unviable economic models like W and CVNA, but for LSPD you can look to imperfect but applicable comps like NCR to get a sense of underlying profitability)

Spruce Point Report

Spruce Point’s 100+ page deck had a couple key points:

1.     LSPD, in September 2021, was wildly overvalued, particularly vs. SHOP (they did a short LSPD / long SHOP pair trade)

2.     The company exaggerated its growth, particularly pre-IPO

3.     Growth is deteroriating – that’s why they’re doing all of these acquisitions

The first was spot on – no company should sustainably trade for >40x gross profit, particularly this business. Turns out that applies to SHOP as well.

The second is silly. Spruce Point points to LSPD no longer reporting unique customers, but rather reporting locations. Locations are the key unit driver for the business. They also point to the company claiming their TAM is massive pre-IPO, and then reducing their TAM estimates afterwards. Practically every startup is guilty of the same thing.

The last piece is interesting. Spruce Point points to shrinking deferred revenue and receivables to make the case that organic growth is declining. That can simply be explained by payments becoming a larger part of the mix, and payments not having any def rev / receivables attached. Spruce Point also points to the blistering pace of acquisitions. I agree that the acquisitions are unsettling, but they seem to all have been done with specific goals (whether it be to accelerate product development or break into a new geography), and more importantly done with wildly overvalued stock, so in some respects they make me feel good about the company’s capital allocation chops.

After speaking with 10+ LSPD formers, I don’t get the sense that this is a fraudulent company whatsoever. People like working there. Spruce Point nailed the fact that LSPD was overvalued. The rest of their arguments were fluff to fill out a 100 page deck.

Risks

There’s certainly mark-to-market risk in this one – for businesses without real FCF, there seems to be zero bid and 5.7x gross profit can become 4.7x really quickly. I just think the risk/reward is skewed at these levels.

LSPD making another acquisition would be tonedeaf, but I get the sense from talking to them that there’s a near zero probability of that with the stock at current levels.

The key risk here is mgmt. not taking the market signal that investors want to see operating leverage and a path to profitability. If incremental margins go in the wrong direction, the stock will be punished. I think you’re getting a good price for this risk but I could certainly be wrong about the direction of travel and actual margins results in year 5.

Catalyst

n/a