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  • Brett Schafer

Not So Deep Dive: Toast Stock (Ticker: TOST)

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Show Notes

(Ryan) What they do: The first line of the S-1, “Toast is a cloud-based, end-to-end technology platform purpose-built for the entire restaurant community.” It’s pretty much a restaurant POS system, but also includes software that can help the restaurant operate. And their platform gets broken down into 3 different sectors.

  1. Subscription services: This includes Point of Sale, Restaurant Operations, Digital Ordering and Delivery, Marketing & Loyalty, and Team Management

  2. Financial Technology Solutions: This includes Integrated Payment Processing and Financial Technology Products like financing solutions.

  3. Platform Services: This includes Reporting and Analytics, E-commerce, and their API/Partner Ecosystem.

(Ryan) History: The idea for Toast was originally conceived over a meal at a local restaurant by Steve Fredette, Aman Narang, and Johnathan Grimm. The 3 of them met as employees at another software company, but that company was eventually acquired by Oracle so they left to start their own thing. The question they apparently asked themselves was “How do we build a mobile app that can streamline the payment experience at restaurants?”

Their first attempt at solving the problem failed miserably according to the founders' letter. Apparently, it had too difficult of a time integrating with older legacy systems and it didn’t understand the actual difficulty of running a restaurant. So they shut that down and started going door-to-door listening to restaurant operators and some of the struggles they had. So after a while, they pivoted from a purely mobile app to a full POS system that connects all the different technology solutions providers into a unified place.

This was ultimately what they went with and they basically added restaurants one at a time just trying to grow their customer base. They had lots of VC funding along the way and went public in September of this year. So brand new to the public markets.

(Brett) Industry/Landscape/Competition:

  • 860k restaurants in the United States, 22 million worldwide

  • I don’t have any TAM numbers but you can extrapolate realistic opportunities from the 47k locations they are serving now

  • Competitors: Square, Clover, PAR Technologies, Olo, etc.

  • Other competitors include anyone that is doing management software for restaurants (including something like Quickbooks too)

(Brad) Management and Ownership:

Christopher Comparato is the CEO

- Hired as CEO in 2015

- Previously led Customer Success Functions at Acquia and Endeca Technologies which are consulting firms

Stephen Fredette is the Co-President and Co-Founder

- Was the CEO from 2011 to 2015

- “Various roles at Oracle

Elena Gomez is the CFO

- CFO since May 2021

- Former CFO at Zendesk

- Senior VP of Finance and Strategy and Go to market at Salesforce

- BOD at Smartsheet and PagerDuty

Aman Narang is the Co-President, Co-founder and COO

- COO since June 2021

- Previous and current board member

- Product Manager at Oracle

The most notable BOD member is a former CFO of Salesforce and Autodesk -- Mark Hawkins

After the offering ownership:

- None of them have any class A shares

- Comparato has 2.28% of Class B shares for 2.37% of the voting power to give a sense of how much of the voting power class B has

- The co-founders own about 12% of the combined voting power

- All execs own 15% of the company

- Pre-IPO Funds such as Bessemer Venture Partners and others own roughly 53% of the class B voting power

(Brett) Valuation:

  • Market cap of $27.3 billion, ticker TOST

  • I’m going to keep this one simple: 107x TTM GP

  • 61.9 million stock options outstanding on 500 million shares

  • 88% of shares currently in lock-up

(Ryan) Earnings:

  • $823M in 2020 revenue, up 24% YoY

  • Last six months revenue grew 105%. So there was clearly a slowdown during covid.

  • 17% gross margins, so gross profit multiples are probably the most important here.

  • In 2019, the gross margin was a little over 9% so it is improving.

  • And it’s actually 22% in the most recent six months.

  • They have pretty large operating losses right now, so not really any GAAP profitability metrics to look at

  • In the latest six months, they did generate almost $40M in revenue which is a FCF margin of 5.5%

  • But SBC was larger than FCF. So make no mistake, they’re reinvesting heavily back into the business right now. As they should be.

  • Each year since 2015, their Net revenue retention rate was above 110%.

(Brad) Balance sheet and liquidity:

Balance sheet & liquidity

- Post the $800 million IPO it has roughly $1.1 billion in cash and equivalents

- Took a $50 million debt extinguishment charge for settlement of convertible notes. Looks like the $176 million in its Long term debt was paid off

- $12 million in interest expense first 6 months of 2021 but then it extinguished the debt

- $330 million in a senior credit facility

- $200 million in warrants for stock

- It uses convertible notes for free cash flow for fundings


Anecdotal Evidence:

  • (Ryan) They all seem the same to me. I imagine the crux of the customer value prop is on the restaurant side, not the consumer side.

  • (Brett) Seems fine. Good product from the consumer side of it.

  • (Brad) I’m sure but I don’t know specifically

Future growth opportunities:

  • (Ryan) Acquisitions (with stock). They actually mentioned this in their S-1, which I didn’t expect. They said, “We intend to selectively explore inorganic product and technology growth opportunities to build out our portfolio and strengthen our ecosystem advantage.” Maybe acquire Olo honestly. Could give some decent in-roads to a few franchises.

  • (Brett) More subscription add-ons. Their NRR has been 110% (wonder what it has been in gross profit) for six years, which leads me to believe the restaurants they just signed up in the past year will be adding more of these non-POS services soon.

  • (Brad) Cannabis! Same as for Olo. The solutions here stink. Commerce is on-demand just like restaurants. 20% CAGR for the next decade. Go for it!

Highlights and lowlights:

  • (Ryan) Highlights: I do think it’s a good business. They’ve demonstrated some operating leverage and they have shown an ability to grow in what I used to think was a pretty commoditized industry. Lowlights: Churn will be naturally high just due to the short lifecycle of restaurants. Not a huge deal, but that probably means more installations which means sustained hardware revenue which actually has a negative gross margin.

  • (Brett) Highlights: Great business model, love the focus on restaurants, think these type of products are very sticky. Lowlights: I’m not sure they’re better enough to beat someone like Square or Clover, although now that I understand the offerings if I was an SMB I would definitely choose Toast. Do not like what they’ve done with options/RSUs. Huge turn-off

  • (Brad) I don’t like the reliance on hardware personally. Competition there is ferocious and the margins stink. Square sells its hardware at cost to sell subscriptions. Can Toast find the same level of scale to embrace the same mentality?

Bull Case:

  • (Ryan) Hard to rationalize any bull case here. Toast already has 48,000 restaurants as customers. Apparently, that is 6% of the US restaurant market. Even if they got to 50% of the market (assuming similar average gross profit per restaurant), they would be trading at a price to gross profit of 15x. That’s not great and that assumes a pretty rosy future.

  • (Brett) They will have to come up with a new business line to make this work.

  • (Brad) The company can continue to find SMB success and can venture beyond SMB to the world of large chains to bolster margins, retention, and brand awareness. Less than 2 restaurants locations per client at this point in time.

Bear Case:

  • (Ryan) Just outright multiple compression. Do you think this will trade at 100x gross profit forever? I doubt it. What’s it going to take to get to FCF yield of 10% on this current price? $2.5B in FCF. I imagine that it will take 10 years or more (at least to get there organically).

  • (Brett) If NRR stays strong and eventually they can do $500 million in GP from their current locations, and they then capture the entire U.S. market, they would be doing around $9 billion a year in gross profit. That is...about what makes sense with the current market cap if you include the guaranteed share dilution?

  • (Brad) Square & co. eat their lunch by undercutting them wherever necessary to take market share. Predatory pricing Walmart style.

Chit Chat Money is sponsored by 7investing. Use our link or enter promo code “CCM” at check-out to get $10 off your first month of the service.

Disclosure: The author and podcast guests are not your financial advisors. Ryan Henderson and Brett Schafer are general partners and portfolio managers at Arch Capital. Clients of Arch Capital may hold securities discussed on this show.

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