Description

NOTE: FOUR's Q2 call is later today (numbers already out). But the math from my re-underwrite was done and I feel this is a 12-24 month story (barring an MBO) anyway, so sharing now. 

EXECUTIVE SUMMARY: Shift4 (FOUR) is an “End-to-End” (integrated) payments processer, meaning it provides both basic payments and gateway services as well as value-added software solutions to merchants. FOUR’s above-market organic growth profile – even assuming meaningful margin deterioration from its move upmarket and continued discount to peers – creates an opportunity for a base case 2-1 risk-reward[1] and a ~4-1 upside r-r even when modelling a ~$50 p.s.FY26E downside which is highly unlikely due to strategic value as well as a clear path to a >2.5x MOIC M/LBO at its current valuation[2].

FOUR LONG THESIS SUMMARY

1. “>25%” organic growth story w/ improving FCF conversion is being obscured by M&A and complex reporting
2. Roll-up story – despite track record of successful integrations and growth from cross-sell – has fomented an unfair discount compared to peers, esp considering organic growth
3. Controlled company where the founder has the financial and governance ability to lead MBO at current levels
4. Aura of “failed” strat alts process earlier this year weighing on stock despite clear strategic and LBO value around current levels, bolstering downside protection
5. Vertical leadership creates high and increasing barriers to entry in core revenue streams; history of expansion into new verticals + geographies organically and via M&A
6. Enormous investment in customer base via capitalized acquisition costs (i.e. FOUR pioneered the model of “giving away” hardware to win business) has led to cash burn historically, but the business has been FCF positive for nine consecutive quarters, and this will increase meaningfully as more new business comes from cross-sell (e.g. >50% LFCF conversion from EBITDA today vs. breakeven/negative in 2021-2022) and recent enterprise wins come online
7. Even assuming a sustained discount to lower-growth competitors, earnings growth should drive a 2x in <3 years.
8. Market is focused on the probability of declining EBITDA margins (largely a function of mix shift) without given much credit for the growth that will be inherent in such mix shift, as well as the higher-quality enterprise customer base this implies

COMPANY OVERVIEW

Introduction: Founded in 1999 by current CEO, FOUR has evolved from a SMB-focused merchant acquirer focused on a single vertical in NA to a global integrated payments provider serving several verticals today, as well as a leading supplier of vertical software for payments applications. Today, FOUR supports >200k customers globally, representing ~$200bn of payments.

FOUR Revenue Model / Products

• End-to-End Payments: ~81% of LTM net revenue (~91% of gross[3]), ~53% FY20-FY23A revenue CAGR, ~35% YoY growth
  • Payments completed via FOUR’s fully integrated payments offering, whether a vender utilizes ancillary services or not
  • KPIs: Volume Growth, Gross Take Rate, Network Fees % of Revenue, Organic Growth
• Subscription and Other: ~17% of LTM net revenue (~7% of gross), ~29% FY20-FY23A revenue CAGR, ~45% YoY growth
  • Software solutions / services ranging from point of sale to inventory management / analytics
  • KPIs: Subscription attach rate to E2E volume and gross / net revenue
• Gateway: ~3% of LTM net revenue (~2% of gross), ~8% FY20-FY23A revenue CAGR, ~(51)% YoY growth
  • Revenue from legacy gateway-only offerings.
  • KPIs: Gross annual decline (segment is in run-off)

Market and competition: Competes in the global Payments market. McKinsey sizes this TAM at $2.2tn in 2023 and projects a 7% CAGR through 2027. Looking at this on a net basis (i.e. applying FOUR’s ~.06% net revenue take-rate) implies a revenue TAM for FOUR of ~$10-15bn implying at 5-10% global market share, up from ~2.5% as of FOUR’s IPO. These numbers are rough and further complicated by FOUR’s verticalized approach, where its market shares are certainly higher, especially in its “more established” verticals (e.g. Hospitality).

WHY DOES THIS OPPORTUNITY EXIST?

• Founder-controlled “roll-up” story: In addition to the discount usually applied to controlled companies, FOUR has largely built itself into its modern form via acquisition. While this has – historically – been successful along both integration and monetization vectors, this serves to obscure organic growth, is deleterious to FCF conversion, and increases the chance of a failed acquisition
• Macro fears: Slowing inflation is a negative for payments companies like FOUR, which generate revenue primarily by earning a spread on payments volume. Further, while FOUR is increasingly focused on Enterprise wins for new business, average customer payment volume of $1m/customer still implies a base substantially composed of SMBs.
• “Failed” H1 2024 Strategic Alternatives: See public commentary on this; it was clear that CEO wasn’t happy with the price relative to growth already embedded in recent wins.
• Deteriorating payment KPIs: Net E2E take rate (net rev. / gross payments volume) has fallen to ~.06% today from ~.08% at IPO. This has largely been explained by management as a function geographic expansion as well as a move upmarket in customer size.

WHERE I COULD BE WRONG / BEAR CASE

1. M&A story continues and keeps obscuring underlying organic growth, driving continued or exacerbated discount 
2. Core payments KPIs – e.g. net E2E take rate – could continue to deteriorate even after “mix shift” impact is fully in #s, suggesting deterioration is a function of competitive pressures as much or more than mix shift
3. M&A story “breaks”, especially in European expansion via Finaro or another transformational purchase
4. Merchants could prefer to use competing payment solutions alongside best-in-class software solutions, rather than integrated offerings like FOUR’s
5. Disclosure around channel partnerships and sales efficiency is opaque; partners (esp. ISVs) offer competing solutions in some areas, which could negatively affect ancillary revenue growth

CATALYSTS: Upcoming catalyst in Q2 earnings (call 8/8 @ 8:30AM ET), other potential catalysts include:

• Renewed take-private or acquisition process
• Sustained higher-than-expected inflation driving total payments volume
• While bolt-on M&A is likely to continue, FOUR’s numbers could appear “more clean” in FY25-FY26 guidance and reporting, highlighting underlying organic growth

RISK/REWARD

APPENDIX A: ILLUSTRATIVE LBO MATH AND SENSITIVITY AT CURRENT PRICE

Catalyst

CATALYSTS: Upcoming catalyst in Q2 earnings (call 8/8 @ 8:30AM ET), other potential catalysts include:

• Renewed take-private or acquisition process
• Sustained higher-than-expected inflation driving total payments volume
• While bolt-on M&A is likely to continue, FOUR’s numbers could appear “cleaner” in FY25-FY26 guidance and reporting, highlighting underlying organic growth