Description

Recommendation

BUY PAR common stock.  PAR is an odd company and therefore qualifies as a special situation.  What makes it odd is that it operates in two very distinct businesses that have zero overlap with each other and present very different growth dynamics.  In an ideal world, an activist investor would be involved but we don’t have that luxury here and therefore the likelihood of the stock being a potential value trap is not insignificant.  The stock trades at $5.11/sh representing a market cap of $80.6mm.  The Company is cash flow positive, practically unlevered and is in a net cash position.  Assuming FY17 EBITDA of ~$11mm, the stock is trading at 7.2x multiple, which doesn’t scream dirt-cheap but also doesn’t suggest excessive overvaluation.

However, what makes this opportunity interesting to me is that the no/low growth Government Technology business by itself represents the vast majority of the Company’s market cap giving investors a very cheap call option on the growing Food & Beverage Technology business that is currently transitioning from a cyclical hardware revenue business to a software and services business model. Note that the Food & Beverage Technology business is not a startup operation – it has been around since the 1970s, has Tier 1 customers, and generated LTM hardware and software revenues totaling $142mm. 

While not a near-term event, I believe the board has started to evaluate selling the Government Technology business and an announcement could come sometime in the first half of 2017.  For a business generating $6.0mm in EBITDA with virtually no capex requirements, it doesn’t seem unreasonable that a buyer would pay at least $40mm for this asset, which would represent value in excess of $2.54/sh.  Keep in mind that the Company also owns real estate that is worth ~$10mm (~$0.63/sh) and has significant NOLs and tax credits that could potentially be worth something. 

Business Overview

PAR provides software and hardware solutions and support services to the global hospitality industry that include restaurants, grocery stores and specialty retail outlets.  The Company sells its software, hardware and services as an integrated solution or unbundled.

Food & Beverage Technology – POS Hardware/Support Service

The Company has been providing POS hardware solutions for over 35 years to 50,000+ restaurants in 110+ countries.  Products sold include POS terminals, tablets and accessories/peripherals (cash drawers and printers).  Product revenues represent ~40% of the Company’s total revenues and ~67% of the Food & Beverage Technology segment revenues.  Often, hardware is sold in combination with software providing some recurring revenues for the Company but there are many large customers that currently only purchase hardware.  Among the outlets where its hardware can be found include table service, QSR, fast casual, bars, nightclubs, theatres, theme parks, zoos, resorts, casinos, and cruise lines.  Two very large Tier 1 customers include McDonalds and Yum Brands – both have their own software solutions and therefore are only hardware customers.  While the Company does make and sell fancy, high tech terminals like its EnerServ series, a big portion of its hardware sales are lower margin peripherals and accessories.  The Company’s hardware gross margins are in the 23 to 28% range. 

PAR’s traditional hardware service revenue consists of installation and training services, and field and depot repair.  Revenues could be generated either under a maintenance contract or on a per need basis.  Hardware support service revenues represent ~20% of the Company’s total revenues and ~33% of the Food & Beverage Technology segment revenues.  Gross margins here are in the 28 to 30% area.  I suspect there is some recurring service revenue here but the bulk of it is tied to hardware sales. 

Selling hardware absorbs overhead and helps keep the lights on for the Company but there’s no growth potential here and the top line will no doubt shrink over time before eventually going away completely.  In a recent quarter, product sales decreased 15.1% Y/Y as large customers cut back on purchases.  Management is not oblivious to this trend and has therefore focused on its software business.

Food & Beverage Technology – POS Software

PAR’s POS software business is primarily driven by its Brink solution, which targets the rapidly growing fast casual segment.  Brink was purchased in 2014 for $10mm.  Different from ordinary POS systems, Brink is a cloud-based POS software solution that does not require a back office computer where customer data is safe, secure, and accessible in the cloud. The software is sold as a SaaS model where customers pay a monthly subscription fee without any upfront licensing fees or long-term contracts, and upgrades are included and performed automatically unlike at legacy POS systems.  Cloud functionality is attractive to franchised operations as franchisors can better manage based on seeing real-time performance and can automatically push updates to all the franchisees ensuring that everyone in running on the same POS systems.  Furthermore, cloud based systems can more easily facilitate aggressive unit expansion.

Brink POS software is integrated with features that includes loyalty programs, mobile online ordering, kitchen video system, guest surveys, enterprise reporting, mobile dashboard.  The software costs roughly $90 per month for the first terminal and is then $50 per month for each of the next three terminals.  On average, each restaurant site generates roughly $165 per month in revenues for PAR and management believes that this can eventually get to as high as $190 per month when additional features are added to the solution.

As of the most recent quarter, the total number of restaurant units operating with Brink POS was in excess of 2,000 and management expects to end the year with around 2,500 units.  So far, the Company has only had success signing up Tier 3 accounts - some notable customers include Five Guys, Pita Pit, Pancheros Mexican Grill and Sonny’s BBQ.  While the lead time to do so is very long, getting a Tier 1 or 2 signed up would be a homerun for PAR.  The current recurring backlog for Brink is $9.0mm.  Management has laid out aggressive targets for Brink – 5,000 and 10,000 restaurant units by the end of 2017 and 2018, respectively.  At 10,000 units, Brink annual recurring revenue will approximate $20mm assuming the current price points.  Gross margins at $20mm should approximate 75%, not inconsistent with other SaaS type offerings. 

Food & Beverage Technology – Food & Safety Software

In addition to POS, the Company is expanding its business into retail, big box retailers, grocery stores, food distribution, and contract food management organizations with PAR’s food safety and task management solution, SureCheck. SureCheck is a food safety monitoring and intelligent checklist solution.  Employees use a mobile device embedded with a suite of sensors, to check food temperature and complete safety tasks throughout the day. As the employee completes each task, the action is automatically logged in SureCheck’s cloud-based software. Temperature data is also transmitted to the software, where it’s measured against data sets for HACCP requirements. If corrective action is needed—for example, if a hot food item has become too cold—the employee receives an alert. The employee can then correct the problem, log the action, and have the information saved to the cloud. By automating food quality and safety monitoring, SureCheck dramatically reduces the potential for human error while saving hours of employee time each day.

Wegmans Food Markets and Wal-Mart are the two key customers for SureCheck.  This is good news and bad news, unfortunately.  The good news is that these two customers instantaneously provide legitimacy to SureCheck and will help drive sales to new customers going forward.  But the bad news is that SureCheck was sold to these two customers as enterprise end-user license deals meaning that the top line and profitability of this business is low.  All future deals, however, will be sold under a SaaS model where customers will pay $40 – 50 per month per device (typical customer will have 2 – 3 devices per store) plus an upfront hardware charge.  Currently, six other potential customers are evaluating the product and one is in pilot.  For the year, SureCheck is on track to generate close to $5mm in revenues but some portion of this is hardware and therefore, not all recurring.  Management has not laid out a longer-term revenue target for this product as they have with Brink but I get the sense that they feel SureCheck could one day exceed Brink’s potential.

Government Technology 

PAR’s Government Technology segment, representing approximately 38% of total Company revenues, provides contract services for the U.S. Department of Defense and federal agencies.  For more than 30 years, it has provided software solutions, systems engineering expertise and geospatial product innovations for motion and raster imagery, light detection and ranging, and geospatial information assurance for the DoD, Federal, State and local agencies, as well as private industry customers throughout the world.  Additionally, it is a leading provider of communication and information systems services in support of the DoD for more than 35 years. The technical services provided with communications stations integrate and support systems that solve the mission-critical communication challenges for defense and federal civil customers.  Beyond this generic description of the business, we don’t much else about the specifics of projects as the work they do is generally top secret and sensitive to national security.

There has been very little top line growth in this segment in recent years but it consistently generates $5 – 6mm in EBITDA every year.  With practically no capex spend in this business, virtually the entire EBITDA falls to the bottom line.  Backlog is a healthy $122mm as of Q3 and so visibility in the business is high.   

Management and Ownership

PAR was founded by John Sammon in the 1960s and retired from his CEO position in 2010.  He remains a board member and is the largest shareholder of the Company with ownership of approximately 30% of the stock.  Since his retirement, PAR has had significant turnover at the CEO and CFO position. Paul Domorski initially replaced Sammon as CEO but he abruptly resigned in 2013.  Ronald Casciano, the CFO at the time, replaced Domorski as CEO but he retired in 2015.  Casciano was replaced by Karen Sammon, who happens to be the daughter of John Sammon and was heading the Food & Hospitality business.  She is also a significant shareholder of the company with 4.3% of the shares. 

Earlier this year, PAR fired CFO Michael Bartusek saying he violated corporate policy by making unauthorized investments with company funds.  PAR said the investments totaled less than $900,000 and were made between Sept. 25, 2015 and Nov. 6, 2015.  A search for a new CFO is underway and in the meantime, Matt Trinkaus, the Company treasurer, is filling in.  More recently, the Company discovered and is currently investigating potential improper import/export and/or documentation of sales activities arising out of conduct in the Company’s China and Singapore offices.  While this latest development is unfortunate, the offices in question represent a very insignificant portion of the Company’s business and don’t appear to signal bigger accounting issues within the organization.

Offsetting some of the negative Sammon influence is Cynthia Russo.  In May 2015, the Company nominated Ms. Russo to the board. Ms. Russo was formerly EVP and CFO at MICROS Systems, a provider of integrated software and services solutions to the hospitality and retail industries.  MICROS was purchased by Oracle for over $4.0bn.  I view her presence on the board as a big positive as the Company transitions from a hardware company to focus on software and services. 

Capitalization

PAR has very little debt on the balance sheet.  There’s a $25mm credit facility that is currently has $4.8mm drawn against it.  There is a small $600k mortgage loan collateralized by owned real estate.

Cash as of Q3 totaled $2.9mm and in connection with the sale of the hotel/spa technology business, PAR is still owed $4.4mm which is contractually due on May 4, 2017.

Total shares outstanding is 15.8mm.  Dilution has been about 1% per year and doesn’t appear to be a major cause for concern. 

Valuation Thoughts

Valuing an odd name like PAR is tricky to say the least.  There’s clearly a holding company type market discount being applied for having ownership of two different businesses.  There’s also a Sammon family discount because they control the boardroom and executive ranks and is the largest shareholder.  Finally, there’s a discount for the years of promised growth that has failed to materialize.  I’m comfortable with using an SOTP approach here because I feel that a sale of the Government Technology business is a high probability mid-term event.  If they can get a reasonable price for this asset, then it can be argued that you’re not paying much for the Food & Beverage Technology business. 

Below are summary financials for the Government Technology business:

It doesn’t seem unreasonable that someone might pay $38 – 50mm for an asset that has a first class reputation with a sticky customer base and has generated consistent profitability over time.  It’s entirely possible that someone could do more with this business and generate stronger top line growth than PAR management has been able to achieve.  One thing I worry about is that given the long history and the attachment that the Sammon family has with this business, there is a risk that they find a way to strip this asset from PAR at a discount to what it could fetch in the market. 

PAR also owns the building that serves as its headquarters.  The building is located at 8383 Seneca Turnpike in New Hartford, NY and sits on 31 acres with square footage of 174,450.  In 2015, the property was appraised at $9.3mm for property tax purposes and based on my conversations with management, they believe it is worth ~$10mm.  There are no current plans to sell this property or to do a sale/leaseback but it does represent a material asset for a company with a market cap of only $81mm.  In my valuation analysis, I assume this asset is worth $8 – 10mm. 

The Company also has federal tax credit carryforwards of $8.7mm and NOLs of $19.9mm that expire in various tax years through 2035.  In addition, the Company also has state NOLs of $8.0mm that expire in various tax years through 2034.  I conservatively assume that these assets are worth $0 – 5mm. 

As mentioned earlier, the Company is still owed a guaranteed payment of $4.5mm from the buyer of its Hotel/Spa business and will collect on this amount in May 2017. 

Putting all this together, buyers of the stock today are effectively paying $13 – 33mm for PAR’s Food & Beverage Technology business.  You’re not getting it for free but I’d argue that its not a lot to pay.

So, what is the Food & Technology business worth?  Unfortunately, this is a difficult exercise given the mix of no growth hardware and service businesses and the emerging SaaS business.  Today it is basically run as a breakeven operation, which probably explains the low implied valuation of this segment.

Given that the hardware and hardware service gross margins are in the mid 20s and high 20s, respectively, it is quite remarkable that a revenue base of $130mm+ produces breakeven profitability.  Even a substandard mature operation should be able to generate $10mm in EBITDA (7.5% margin) on this revenue base.  What I believe is happening is that PAR is making money on its hardware related revenues – unclear how much given limited disclosure but a 7.5% EBITDA margin seems reasonable – but is funneling all the profits into developing and growing the Brink and SureCheck software businesses.  If one believes that $10mm EBITDA is doable for the hardware and hardware service business, then it would not be unreasonable to assume that it is worth 4.0 – 5.0x EBITDA, or $40 – 50mm.  This works out to ~0.35x revenues, which doesn’t seem overly aggressive for a vendor that supplies to Tier 1 restaurant and retail companies.

Brink and SureCheck will generate at most $10mm in revenues in 2016 and the Company is spending about the same amount per year trying to get them off the ground.  Does this make good strategic sense?  It’s unclear at best given what we know today.  If this $10mm per year spend is able to create a SaaS business that generates a $20 – 30mm growing top line by 2018, then it will have been worth it.  Assuming a multiple of 2.0 – 3.0x, this revenue stream could potentially be worth at least $40 – 90mm, if not considerably more if the growth rate remains high.  If Brink doesn’t get to the $20mm target by 2018 and SureCheck fails to gain traction, then this $10mm per year spend will prove to be a very value destructive capital allocation decision.

In summary, a buyer of this stock is betting that management is successful in changing the Food & Beverage Technology business from a cyclical hardware revenue profile with heavy customer concentration to a diversified customer base profile based on software and high tech solutions.  Unlike many other similar transformation stories out there today with high valuations, heavy dilution, and large cash burns, I don’t believe that PAR investors are paying up for this optionality at the current valuation, which makes the stock interesting to me.

Risks To Consider

·     If Government Technology does get sold, management may misallocate the capital by buying more software companies at high valuations.  They’ve done this before and it wouldn’t surprise me if this happened again. 

·     With the legacy hardware business in a likely permanent decline, it is critical that management continue to right size the organization so that losses are not incurred.  So far they’ve handled this issue well but its something that needs to be monitored on a quarterly basis. 

·     Restaurant struggles in recent quarters and years are well documented and understood by most investors.  Should the trends continue, both PAR's legacy and emerging businesses may be negatively impacted.

Catalyst

·      Seperation of the Government Technology business from the Food & Beverage Technology business. 

·      Continued progress on the Brink ramp from the current recurring backlog of $9mm to $20mm by year end 2018.  

·      Converting the current large SureCheck pilot customers into paying customers and getting revenue run rate closer to that of Brink.