Description

PAR Technology Corporation (PAR) was written up as a long by "offtherun" over three years ago. We are recommending a short position in PAR. I should preface this write-up by saying I am particularly irritated by the “New Year” euphoria taking hold among some small and micro-cap stocks - mainly the shorts in our portfolio and not our longs - and eagerly await the day when gravity will take hold of some of these ridiculously priced stocks. I will also add that I may not dot every “i” and cross every “t” in my write-up. Part of the message here is to see the forest for the trees.

PAR’s business strategy is to transform itself from a sleepy purveyor of traditional POS systems primarily to large QSR restaurant operators into a cloud-based SaaS solutions provider combining POS and back-of-restaurant systems. The bull argument for PAR is predicated on a comparison to a tech unicorn in the SaaS restaurant POS space named Toast. I will attempt to illustrate the weakness of that comparison and the excessive valuation afforded PAR’s SaaS POS offering.

PAR has two operating segments with three lines of business:

• Restaurant/Retail

• Legacy POS hardware systems and support services for restaurant operators, particularly large QSRs (which PAR labels as the “CORE” business)

• Brink POS is a cloud-based SaaS software solution and hardware offering for restaurant operators, particularly in the QSR and fast casual categories

• Government: Solutions and services for the US DoD and other federal agencies.

I will first look at the Legacy POS business and the Government business and posit a value for them to subtract from PAR’s enterprise value to isolate the price the market is placing on Brink today.

Legacy POS

We would call this a mediocre business at best. Our perception is that historically the likes of McDonald’s and Yum! Brands did business with PAR to keep other large vendors honest. There is considerable customer concentration with McDonald’s and Yum! accounting for 32% and 47% of PAR’s total sales in 2018 and 2017, respectively.

Profitability is sparse in this business. A few data points to illustrate this:

• From 2014 to 2018, the gross margin of the Restaurant/Retail segment (arrived at by combining Product and Service sales on the Income Statement) declined from 27.9% in 2014 to 23.3% in 2018

• From 2014 to 2016, presumably before Brink began ramping and significantly affecting the financial statements, segment Operating Income margin for Restaurant/Retail averaged 0.7% (yes, less than 1%)

• For the 9 months YTD, gross margins in Restaurant/Retail have declined 30 bps vs. prior year from 26.7% to 26.4%

• Since Brink is presumably in “growth” mode, the Restaurant/Retail segment is now doing a great job of generating Operating Loss to the tune of ($19.2MM) on a TTM basis

Brink was purchased in September 2014 when it had a roughly $2.3MM sales run rate. We have not found a disclosure of 2018 revenue for Brink, but we would estimate it at approximately $25MM, or ~19% of 2018’s Restaurant/Retail segment revenue

• Why would gross margins decline if Brink is adding theoretically high margin SaaS revenue to the mix? One important point to mention about Brink is that around 45% of revenue comes from sales. Why should that garner a premium multiple?

Our analysis only goes back to 2014 since PAR changed the presentation of its financials with the November 2015 divestiture of its Hotel/Spa solutions business within its Restaurant/Retail segment (formerly labeled Hospitality). Under its old presentation from FY 2008 to FY 2014, gross margins in the Hospitality segment averaged 30.9%.

• Over this same period under the old presentation pre-Brink segment Operating Income margin averaged -2.6% (yes, negative).

A simple observation is that over a ten-year period, there has been margin degradation in this business notwithstanding a revenue model change to SaaS

PAR’s Restaurant/Retail segment saw sales decline $37.5MM in 2018 despite growth in Brink, which management explained in its 2018 10K MD&A:

• The decrease was a result of lower Restaurant/Retail hardware revenue and corresponding hardware support service revenue from our traditional tier 1 customers as some of these customers completed significant refresh projects in 2017 which were not recurring in 2018

So we have a declining, low margin (mainly hardware at ~60% of YTD revenue) Legacy POS business. What is that worth? YTD revenue annualized is ~$73MM, so let’s say $75MM. With minimal profitability and negative secular trends due to the advent of SaaS solutions (which the company itself is trying to capitalize on), we would apply a revenue multiple of 25-30 cents on the dollar. Someone might pay more for customer relationships, etc., but it appears to us that those big QSR customers never allowed PAR to make much money so why would they allow an acquirer to do so. We posit a value for Legacy POS of $75 x 0.25-0.30x = $19MM to $22MM

Government

This is a butts in seats business. Private companies have made a living off the DoD for years, especially when the George W. Bush administration was in office, and PAR has participated in this market for some time. We won’t even ask the question why the Government business was ever part of a POS systems company.

We would also call this a mediocre business at best. Some virtues are that it is hard not to make money in this business, and there has been consolidation in the space. PAR’s Government segment revenue has declined over several years. In 2014 and 2015, revenue was approximately $88MM vs. 2018 revenue of $67MM and TTM revenue of $62.5MM. This business does make money, however:

• Gross margin has even increased since 2014. 2018 and TTM Gross margins were 10.7%

• With not much cost to serve a limited set of customers, Operating Income margins are close to gross margins at 10.2% in 2018 and 8.7% TTM, which compare well with peers

So what is this business worth? PAR’s Government business is miniscule compared to the much larger publicly traded companies. A list of public comps includes BAH, SAIC, LDOS, CACI, MANT, VEC, VSEC.

• The smallest of these companies, VSEC, generated $738MM in TTM revenue, while the next smallest, VEC generated $1.35BB

• These seven companies trade at a median multiple of TTM revenue of 1.2x with a range of 0.5x  (VEC) to 1.8x (BAH)

• Using a range of 1.0-1.2x TTM revenue of $62.5MM for Par Government, we arrive at a value range of $63-$75MM

Combining the asset value estimates for Legacy POS and Government, we arrive at $82-$97MM. With PAR’s current EV of $509MM, that implies a price for Brink of $412-$427MM. The next question is whether this is justified. Spoiler alert: we say “No.”

Brink POS

PAR acquired Brink in September 2014 for $10MM (paid in installments) plus $7MM contingent consideration when the company was generating about $2.3MM in revenue (for all of 2014).

Bulls emphatically argue for the cheapness of PAR by citing the valuation of a private company called Toast that is arguably the leader in the SaaS POS market. We will share what we know about Toast and see how Brink stacks up. We’ll also share some insights we have digging into the minimal and inconsistent disclosures about Brink financials and metrics.

Toast

Toast describes itself as “the fastest growing restaurant management platform in the US.” Toast has reportedly raised over $500MM since its founding in 2011. In July 2018, Toast raised $115MM at a $1.4BB valuation and then $250MM in April 2019 at a $2.7BB valuation. https://www.forbes.com/sites/alexkonrad/2018/07/10/billion-valuation-for-software-toast/

https://pos.toasttab.com/news/toast-announces-250-million-funding-led-by-tcv-and-tiger-global-management

Management has shared that revenue grew 148% in 2018, leading some analysts to estimate 2018 revenue at $175MM. The number of sites operating Toast is also unknown but has been estimated at 20,000.

https://reformingretail.com/index.php/2019/04/04/our-analysis-of-toasts-250m-fundraise/

If these estimates of Toast’s scale are correct (and they are a year old), then Toast would have been generating $8,750 of revenue per site in 2018.

Let’s say Toast’s growth rate declined in 2019 but that its revenue grew by a similar dollar amount - $100MM - from 2018 to 2019. At a $2.7BB valuation and ~$270MM of revenue, Toast would have been valued at 10x revenue in its last financing round.

How does Brink compare?

From a combination of PAR’s Q3 2019 10Q, earnings release and transcript, management shared the following financials and metrics for Brink:

• 9,300 active sites - so less than half Toast’s estimated size as of a year ago)

• Current ARPU of $1,985 - so less than 25% of Toast’s estimated revenue per site as of a year ago

• $17,900 of ARR (Annualized Recurring Revenue) - so under 7% of our estimate of Toast’s 2019 revenue

A word about this ARR. We believe management is being intentionally opaque about Brink’s revenue composition. Let’s look at Q3 revenue for example:

• In the latest 10Q MD&A management disclosed that Brink revenue was $10.9MM in Q3 and also disclosed that Product Revenue was $5.1MM (47% of total Brink) and Service Revenue was $3.4MM (31%)

• But that leaves $2.4MM (22%) that is unaccounted for. By virtue of the description of Brink revenue in the 10K and management commentary on prior earnings calls (notably Q3 2018), we conclude that this revenue is a combination of professional services/implementation services and call center services revenue, arguably low margin types of revenue

• And in noting the $17.9MM of ARR on the Q3 call, management stated this was an increase of $4.1MM or 30% over a year ago

• “ARR for Brink at the end of Q3 is now $17.9 million, an increase of $4.1 million and 30% from a year-ago”

• If the above is the case then ARR ending Q3 2018 would equal $13.8MM. But management on the Q3 2018 called out a different ARR number that appeared to be just for the software portion of Brink

• “Total monthly recurring revenue exiting the month of September was approximately $892,000...”

• “In addition, the annual recurring SaaS revenues, Brink SaaS revenues, at the end of Q3 is now $10.7 million...”

• Management also commented on the Q3 2018 call:

• “The way we report annual revenue per unit, ARPU, we are including both the SaaS -- the Brink SaaS revenue and the Brink call center revenue.”

• New management lately has not bothered to note this composition of Brink revenue, leaving it to investors to piece together the Brink revenue from the MD&A. The cynic in me sees this conflation of software and call center revenue as misleading

The point of this being that Brink is not some pure-play, high-margin, recurring SaaS software like so many other enterprise software companies that have garnered high multiples. At best only 1/3rd of Brink’s revenue is recurring software and given the absence of margin improvement for PAR’s Restaurant/Retail segment as a whole, we are left wondering if there margins are any better than the Legacy POS business.

To us, this begs the question: what is call center revenue worth? Looking at a sample of call center operators - TTEC, SYKE, SRT - they trade at 0.9-1.0x revenue. Are we missing something?! It’s worth noting that Toast, too, reportedly has a component of its revenue in the form of payments processing, which should not garner the same multiple as Toast’s software revenue. Still, we would pay a much higher multiple for payment  processing revenue than call center revenue.

If one uses the $17.9MM of ARR (which includes call center revenue) with the implied Brink valuation above of $411-$426MM, that yields a “revenue” (equating ARR with revenue) multiple of 23-24x. And a big portion of that “recurring” revenue is not even software revenue but call center revenue! If we assume that is 25% of the recurring is call center revenue, that would make the software component ~$13.5MM making the implied multiple of software revenue even higher than 23-24x (in fact, 30-32x).

Based on what we know about Toast - its scale, its scope, its revenue per site - how can Brink be worthy of such a multiple premium to Toast?

One more point of comparison with Toast: at the time of their last financing round, Toast talked about the kind of investment they planned to make:

• April 1, 2019: “Toast will invest over $1 billion in research and development -- over the next five years -- to continue building software and hardware designed specifically for the restaurant industry.” https://pos.toasttab.com/news/toast-announces-250-million-funding-led-by-tcv-and-tiger-global-management

Reading that, we looked for the amount that PAR is spending on R&D. While PAR does not specifically break out Brink R&D (and has noted that R&D increases are due to spending on Brink), PAR’s annual R&D across all of its businesses has trended as follows:

• $12.0MM in 2017

• $12.4MM in 2018

• $12.6MM TTM

So we have PAR spending ~$12.5MM vs. Toast planning to spend $200MM. I will let readers draw their own conclusions.

How else has PAR allocated capital to grow? They did two acquisitions in 2019.

• In December 2019, PAR acquired Restaurant Magic, a provider of a suite of cloud backoffice applications. PAR paid $42MM for $8+MM of ARR

• In September 2019 PAR acquired the Drive Thru Communications business of 3M for $8.4MM total value. This business sells headsets, base stations, charging stations, etc. to support restaurant drive-thru operations. TTM revenue was $18MM

• We guess when you have convinced the market to pay an enormous multiple for any kind of revenue, then you will pile on any additional revenue you can

In Conclusion

As we have tried to illustrate, PAR consists of two mediocre (at best) businesses that by our assessment are worth a combined $82-$97MM, which by arithmetic leaves its third business, Brink, priced at ~$410-$425MM (using current PAR EV of $509MM, excluding operating leases). And Brink is being valued at ~30x its true software ARR. And Brink stacks up poorly on multiple dimensions to a high-flying, venture-funded company called Toast that is a) well-funded and b) investing aggressively to build solutions for the restaurant industry. 

Why is the market so infatuated with Brink? There is growth, but at 30% (based on management’s generous ARR definition), it’s not as if Brink’s growth is astronomical. We don’t know when investors wake up to the reality of Brink, but we believe gravity is an ineluctable force.

Risks to Consider

Continued irrational valuation of Brink.

Catalyst

Catalysts

Continued declining revenue and operating losses for PAR.

Growth rate of Brink ARR and revenue flattens or declines.