08/14/2020
Disclosure: I own this stock and plan on continuing to own it
While PAR Technology (PAR) has been around for over 40 years, it is currently undergoing a transformation that was started in late 2018 and has been sped up this year because of COVID-19. The company has two business segments, restaurant point of sale (POS) hardware & software and government contracting for Intel Solutions and Missions System. While government contracts represented 34% of the company’s revenue in 2019, this report will focus on restaurant POS as that is the business segment undergoing the transformation and will drive the future growth of the company. PAR is also looking at selling its government contract business to focus on restaurant POS.
PAR’s restaurant POS business has two parts, hardware and software. The hardware business consists of a POS terminals, tablets, kitchen display systems, drive-thru communication devices, and kiosks. The drive–thru communication devices segment was acquired from 3M in Q3’19. These hardware options allow a restaurant to adjust to changing customer preferences for less human contact, easier ordering and payments.
The software business revolves around the company’s Brink POS software. The software is incredibly flexible and can be used by a single POS unit or scale up to run an entire enterprise. The software is cloud based and the platform allows restaurants to integrate other services such as mobile/online ordering, loyalty programs, kitchen video systems, guest surveys, and any other features a restaurant might need. Through the acquisition of Restaurant Magic in 2019, Brink offers full back-office cloud-based software. Brink and Restaurant Magic will be discussed in more detail in a moment as they are going to be the key drivers of PAR’s business going forward.
Customers
The company focuses on quick serve restaurants (QSR) and fast casual restaurants but has been investing in hardware and software to grow its presence in the table service restaurant segment.
Brink and Magic Restaurant
Every industry is going through a digital transformation and nowhere has the urgency of that transformation been heightened more than the restaurant industry. The businesses that are helping with that transformation are Software as a Service (Saas) companies, the current darlings of the stock market. PAR’s Brink and Restaurant Magic software are helping its customers by allowing them to take advantage of the industry trends listed earlier. Removing friction around ordering (in-person, online, and delivery), increasing delivery channels (drive-thru, pick-up, delivery) and allowing for easier order customization is creating a win-win for PAR and its customers. These and many more services that are part of the Brink ecosystem that will help restaurants thrive in the new era.
Yes, the POS and back-office with Brink and Restaurant Magic increases efficiency and makes the restaurant owner’s job easier, but the real benefit is when PAR’s software helps increase revenue for the restaurant. The benefit that PAR recognizes is recurring revenue with high gross margins, and if executed properly, little churn.
When people think about POS software, they think of companies like Square, Clover, and PayPal. Those companies generate a significant portion of their revenue through payment processing. This is not lost on PAR. The company finally rolled out its own proprietary payment processing service at the end of Q3’19. Not only does this create a fast growing source of revenue for the company, it gives it access to new data that both PAR and its customers can use. Payments also allows the company to help customers finance the purchase of PAR’s hardware. While PAR’s POS products are less than 15% of a restaurant’s buildout, the ability to finance part of the buildout will help expand the company’s customer base.
Hardware
PAR’s POS terminal has been an approved partner of McDonald’s franchises since 1980. The company has also partnered with Yum! Brands restaurants, Subway, and Carl’s Jr./Hardy’s. Below you can see its penetration in to each company’s locations.
Through PAR’s acquisition of 3M’s drive-thru headset hardware, the company can now help restaurants buildout and improve their drive-thru experience. There is considerable overlap with the company’s existing terminal customers, but the acquisition added Starbucks, Chick-fil-A, and Dunkin’ Donuts as customers. This is important as drive-thru becomes a more prominent revenue channel for restaurants that offer it and a new revenue channel for those that are currently building it out. PAR also offers contactless payment hardware for drive-thru.
Continuing on the theme of limited/zero human interaction at QSR and fast casual restaurants, PAR offers free standing, wall mounted, and countertop kiosk for ordering and paying. McDonald’s believes kiosks will be more prevalent going forward.
As the company is looking to expand its customer base, it now offers tablets for table service restaurants for ordering and payment.
These products, while not as appealing to investors as software due to their one-time nature of revenue and smaller gross margins, are an important part of expanding Brink’s presence.
Management
Besides the current market opportunity, company management is my favorite part of this company. The current CEO, Savneet Singh, was first made interim CEO in 2018 and became the full-time CEO at the beginning of 2019. While he is young (an asset in my mind), he brings tremendous entrepreneurial and software experience to the company. I was first learned about Savneet when he was interviewed on Patrick O’Shaughnessy’s podcast Invest Like the Best. At the time Savneet was the co-founder of the venture capital firm Co-Ventures, and building the Berkshire Hathaway of software companies with his company Tera Holdings. He had previously built an electronic platform that allowed investors to trade and store physical precious metals.
When he took over as CEO of PAR, the company was in terrible shape and had been mismanaged. He realized the crown jewel of the company was the Brink software, an untapped asset that the company had acquired in 2014. He has since trimmed and rebuilt the executive team, improved balance sheet liquidity, made Brink the focus the company’s investments, and is now turning PAR into a 21st century enterprise SaaS company.
Through his shareholder letter (one of the best I have ever read), interviews, and comments on quarterly earnings call, it is obvious Savneet understands the importance of capital allocation, running a decentralized organization, and building software that will not only create value for shareholders, but will delight customers. When pushed by analysts for his opinion on M&A, he has been constant in saying that any software acquisition would not only have to be a product PAR could in no way improve upon if build organically, but the team behind the software would have to fit culturally with PAR. He is very transparent about PAR’s value proposition to potential employees. While the company may not offer the typical perks you would expect to find at a software company, it does offer autonomy and the ability to grow beyond one’s potential.
The three quotes from his investor letter demonstrate my excitement about Savneet leading PAR.
PAR’s strategy for growth and success
“Today, we at PAR believe we are moving towards the next evolution– software as a platform. A world where the best software products enable customers to innovate by leveraging the building blocks developed by others (i.e., tools or collections of tools from different providers). The best products will be modular, allowing users to use collections of existing protocols or APIs to build a customized service for their business. Every building block added to the platform, makes the platform inherently more valuable. This model moves another step away from the perpetual license model – it’s the difference between extracting value vs. adding value. Platforms encourage data sharing, movement of protocols, and leveraging the building blocks of the modern-day software supply chain. They are definitionally not closed. I believe PAR will be the software platform for the restaurant of tomorrow. The idea of being a point of sale application will become a vestige of the past.”
Building software
“Software margins, like all other products, will decline over time. While investors and competitors pursue growth at all cost, we stay firmly rooted in the reality that the winners of tomorrow will be those who focus on high-quality products, in a cost-effective manner while delivering a scalable service model.”
Supporting the customer
“In addition, we have pushed a culture of empathy for our customers by providing radical transparency. An empathetic team will always remember the customer, the employee behind the customer and the end customer being served.”
Competition
PAR has two types of competitors, legacy enterprise software companies and venture backed POS/SaaS start-ups. While Brink can be customize to fit tier 3 (2-100 locations) and tier 4 (single location) restaurants, PAR’s current growth strategy is focused on enterprise level restaurants at the tier 2 (101-1,999 locations) and tier 1 (2,000+ locations) level. This shrinks the competition analysis to the legacy enterprise software companies. Toast is a $4.9 billion venture backed start-up that recently let go 50% of its employees and its rumored that most of its enterprise sales team was part of the layoff. Toast will continue focus on tier 3 and 4 restaurants.
NCR (ticker: NCR) competes with PAR with its Aloha software and POS hardware. The Aloha system is used by over 75,000 restaurants around the world including Chipotle and 38 of the top 50 quick service restaurants. But NCR is more than just a restaurant POS company. NCR is a global manufacturer of ATMs, builds software for banking, hospitality, retail, and restaurants, and various types of payment terminals. It has a market cap of ~$2.5 billion and employees 36,000 people. When Savneet talks about competing against legacy software companies with poor customer service, its NCR and Oracle that he is talking about. Hospitality, which includes hotels, restaurants, and entertainment venue, represents only 13% of the company’s revenue and has seen no growth over the last three years. Reading the available reviews of Aloha proves that there is demand from the restaurant industry for a better POS software product. Its
Market Opportunity
The chart above is a break down the QSR, fast casual, and casual restaurants in America by tier (defined during the competition discussion). Brink POS software is currently installed in 10,280 locations and Restaurant Magic is currently installed in over 5,000 locations with only ~2,000 locations running both pieces of software. While Brink and Restaurant Magic are designed for enterprise level restaurants, tier 1 & 2, the customization and flexibility allow them to be run at tier 3 & 4 restaurants.
Capturing 10% of the QSR and Fast Casual tier 1 & 2 markets would almost double the current install base of Brink and almost quadruple the Restaurant Magic install base. Because the Brink POS software can now offer the full suite of features a restaurant needs both at the front of the house and back-office, the additional features should increase Brinks current ARPU of ~$2,000 currently to potentially $8,000 over time. The typical enterprise level restaurant spends $10,000 a year on software. A restaurant owner’s job is to run the restaurant in the most efficient manner possible. Brink allows the owner to have one vendor for all software services. Efficiency and multiple revenue channels are the value propositions of Brink.
Valuation
PAR is 18 months into its transition from a government contracting/restaurant hardware business to an enterprise software company. For four of those months, the country has been dealing with a global pandemic and the biggest disruption in the history of the modern restaurant industry. Any valuation is going to require some faith that the QSR and fast casual restaurants will survive this threat, that PAR has developed a product that will help those restaurants in this new era, and Savneet has built a team to create value for PAR’s customers and shareholders.
If you assume PAR can sell its government contract business for $100 million and the hardware business is worth approximately $50 million, the next step is to figure out what the market is valuing PAR’s ARR. With 10,280 locations running Brink with an ARPU of $2,019 and 5,064 locations running Restaurant Magic with an ARPU of $1,461 that equates to $28mm of ARR. Subtracting the value of the government contract and hardware business, shareholders are paying ~18x annualized recurring revenue. That sounds very expensive without any context, but very much within valuation range of cloud-base SaaS companies. The BVP Nasdaq Emerging Cloud Index is trading at EV/Annualized Revenue of 16.9x. Lightspeed is a Canadian POS SaaS company focused on the retail sector with a market cap of $3.6 billion. The company generated $133 million of annualized software and payment revenue in Q1 and is trading at over 27x annualized revenue. Remember, PAR just started rolling out its payment service late last year, a service that generates most of the revenue for other POS SaaS companies.
If PAR can double Brink’s current locations and ARPU, then shareholders are currently paying 6.5x ARR. This seems very doable given the company’s has long-term partnerships with the some of the largest QSRs (McDonald’s, Yum!, and Dairy Queen), it just started rolling out its own payment service, and is one of the few companies that can offer back & front office enterprise software along with the hardware to help restaurants transform during this new era.