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Toast: A 30% Correction
Plus: Is Paramount Selling Showtime?
Good Afternoon!
Happy March everybody! The warm weather is getting closer and closer. When I hear March, I instantly think Spring Training and the fact that the MLB is finally back.
Did you all hear about the new pitch clock changes for this year? In an effort to speed up the (too boring and long) games, pitchers now have 15 seconds between pitches to start their motion for the next pitch.
I am so excited about what this can mean for baseball and also grateful for the incredible videos coming out of Spring Training as the players learn the new rules. This is exactly what the MLB needed.
Recently, here at The Crossover we have been pretty focused on the public markets as we were in the heat of earnings season. Next week, we will be venturing back into venture land with an expert interview discussing Wiz's $300M Series D and what this means for the cyber security landscape.
Also, make sure to check out my thoughts below in the Media Minute section where I break down Paramount rejecting a $3B+ offer for Showtime.
Showtime!
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DEEP DIVE
Toast: A 30% Correction.
Introduction
I never thought I would spend more time thinking about a mock portfolio than I do now with The Crossover Portfolio. What started off as a way to put some type of accountability behind my analysis has quickly become a lesson learning machine for me and something that I manage as I would a real money portfolio.
Why? Because one day I hope to make big money decisions with real money, and it is much better to learn these lessons through a mock portfolio than an actual one!
Ever since my first analysis on Toast a few months back, two ideas have become clear:
Toast is an incredible company
Toast is overvalued (in my eyes)
Ultimately, on July 29, I decided to build a small position in The Crossover Portfolio @ $16.06 with the mindset that I would more than happily pick up more if there was a dip. I did think the stock was overvalued, but not too overvalued, and was confident that over time, they would grow into their valuation.
As the new year began, to my surprise as well as so many in the markets, growth/tech stocks had a great start to the year and Toast was up over 45% YTD (pre-earnings) and our position was up ~60%. At a $12B+ valuation, ARR of $866M, profitability quarters away, and a macro environment I was skeptical of how Toast would hold up over '23.
I wanted to sell.
What also pulled me towards selling? The fact that there are other phenomenal growth companies that are growing nicely WHILE ALSO generating meaningful FCF like Digital Ocean and Elastic.
So. Why would I stick with Toast?
Some of my best investments over the past decade, as well as my dad’s who I have learned so much from, have been from smaller investments in great companies that you do not touch for years and years and just watch them compound.
With such a small position in Toast, this company fit the bill and even though I was uncomfortable with the valuation, I stuck with it and happy I did.
“But Alan. Toast is down 30% since earnings. How could you be happy you stuck with it?”
Great question. The answer is because I was happy with the fundamental approach, logic, and reasoning that I took to holding on. Ultimately I feel that this long term mindset will help me be a great investor in the years ahead.
Now with the stock down 30% since earnings, what am I doing with Toast? Are we loading up and buying the dip or sticking with what we got?
First, let’s take a look at Toast’s Q4 and see what we are working with.
Earnings & Guidance
Here were the key financial metrics from Toast’s Q4 earnings compared to Wall Street’s expectations:
Revenue: $769M (actual) vs. $753M (estimates)
EPS: -$0.19 (actual) vs. -$0.50 (estimates)
The revenue in Q4 represented a nice beat of 50% YoY growth, but the -$0.19 loss represented a $99M loss and was a much bigger loss than analysts expectations. In the quarter, the company also achieved some significant operational accomplishments including:
Growing ARR, the key financial figure with Toast to look at as we will break down later, to $901M (59% YoY growth)
Added ~5,000 new restaurant locations in Q4 alone taking total restaurants to ~79,000 (40% YoY growth)
Gross Payment Volume (sales through Toast platform) up to $25.5B (49% YoY)
These are serious numbers.
What is also exciting for Toast bulls is that even with all that company has accomplished, there is still a massive opportunity in front of them as there are over 860K restaurants domestically and 2M globally. In other words, Toast has just 9% of US restaurants on its platform.
What does Toast see 2023 looking like?
In Q1 ‘23 Toast projects around $745M to $775M in revenue (compared to analyst expectations of $751M). For FY ‘23, Toast expects revenue of $3.57B to $3.66B vs. analyst expectations of $3.62B. The company also guided an adj. EBITDA loss of -$10M to -$30M for ‘23 vs. analyst expectations of -$19M.
Revenue of $3.6B would represent 33% top line growth YoY and adj. EBITDA loss of -$20M would trim losses by just under $100M as the company had a ($115M) adj. EBITDA loss in ‘22.
Toast’s forward looking forecast does look solid, however, a big beat likely was needed to keep the momentum for their stock.
Why ARR?
As we have discussed in the past, it is important to recognize that top line revenue should not be the key top line level metric to look at for Toast, but rather ARR. Why? Toast has 4 key revenue streams:
Subscription Services – Fees charged for customers to access SaaS like POS, kitchen display system, invoice management, digital ordering, etc.
Financial Technology Solutions - (Mostly) fees paid by Toast customers to facilitate the transactions on the platform. Includes a percentage of the total value of transactions processed as well as a small basic fixed fee.
Hardware Revenue - Revenue earned from the sale of of terminals, tablets, handhelds, and other Toast accessories
Professional Services - Services that Toast provide when new restaurants join platform or existing Toast customers add new products to their
Here is the financial breakdown of these respective revenue lines:
As you can see, a far majority of the company’s revenue comes from their FinTech solutions which has 21% margins. The real sexyness from the business is in the 65% margin SaaS services which we will touch on more later.
The significant losses in Hardware Revenue and Professional Services are sold at a loss as they are integral to launching and ultimately building towards the higher quality revenues. (Like Roku selling their devices at a loss to ultimately get the high margin platform revenues).
Therefore, Toast highlights their ARR, which they consider to be the Subscription Services plus FinTech Solutions revenue.
ARR in the quarter grew to $901M which represents 59% YoY growth. This also means, after the 30% drop in share price that the company is trading at ~11x ARR.
Speaking of Subscription Services, Toast is showing great momentum in their ability to sell additional SaaS products to restaurants and take more and more of their wallet share.
As you can see, 65% of Toast locations have more than 4 SaaS products, a 500 BPS increase year over year and 41% of locations have 6+ products, a 900 BPS increase YoY.
Toast Capital
In the Q4 earnings call, we also got a good update on Toast Capital. Toast Capital is a loan program through Toast where they offer restaurant loans ranging from $5k-$300K over three various terms: 90, 270, and 360 days.
What is really interesting about this opportunity is that Toast leverages the knowledge and data they have from the restaurants past data to underwrite, process, and manage risk. The loans are also serviced using a fixed percentage of daily sales, decreasing the risk of the loan significantly.
This provides a unique opportunity to Toast to create an additional source of revenue making money from marketing, underwriting, and servicing the loans. Toast does work with a regulated bank to manage and hold the loans making it a balance sheet light business model.
In Q4, Toast saw $24M in gross profit from Toast Capital alone. The company shared an example on the call of a Georgia steakhouse that used funding from Toast Capital to install powered curtains to enclose the outdoor patio adding 70 new seats for the winter. This helped the restaurant grow sales 20% YoY.
One final note – ~80% of Toast Capital have returned back to Toast Capital for a second loan. There is serious flywheel potential here for Toast with Toast Capital and what it could mean for the overall business.
The company has not shared any annual figures for Toast Capital in 2022, but as we go into 2023 it is a very interesting business line and development to monitor.
Alan's Angle
From one perspective, it feels as if Toast is just getting started and has displayed great ability to move clients to more and more of their products once they get them on the platform. Also, something like Toast Capital shows that the company has a lot up there sleeve of different ways to monetize the stronghold that they have on restaurants domestically.
I also am intrigued by the likelihood that additional revenue from this point forward will greatly out pace SG&A growth – in other words, the power of scale.
Yes. 11x ARR is not cheap, but is it really that expensive for a company growing clients and revenues at the velocity they are?
The other perspective, the one which I find myself aligning with more closely at the moment is that everything from above is true, but it just does not warrant additional investment from The Crossover Portfolio strictly due to valuation.
This past year, Toast had -159M in negative FCF. The company expects to be leaving 2023 at an adj. EBITDA profitaiblity level. Adjusted EBITDA, is very different than FCF positivity.
I would be more excited about increasing my stakes in Elastic and Digital Ocean at these levels - even though their valuations have increased as of late. Why? As I touched on earlier, being FCF positive in this environment I just think is critical in the eyes of the market.
At the same time, if Toast continues to get hit, I will be a buyer. At this point, however, I am doing my favorite thing when it comes to investing – nothing at all.
-Alan
THE CROSSOVER ARCHIVE
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Media Minute
On Tuesday, the WSJ reported that David Nevins, former Showtime top executive, tried to acquire Showtime for $3B+ from Paramount in a deal backed by PE firm General Atlantic.
Here were some key points around the rumors:
Paramount declined the offer with CEO Bob Bakish saying that "there is enormous value to unlock with the integration of Showtime and Paramount+" and that $PARA's operating plan would create more value for shareholders.
This is not the first time that Showtime has been in the rumor mill as two years ago Mark Greenberg, another seasoned former Showtime exec, tried to buy the premium entertainment network for $6B backed by Blackstone. Last year, Lionsgate also approached Paramount about merging Showtime with Starz.
I don't know if there is anyone on Wall St. that would disagree that Paramount's sum of parts valuation is 2-3x its current equity value of ~$14B. Heck, spinning off their legacy broadcasts and cable networks that rip off ~$5.5B in operating income would likely sell for significantly more than the current market cap in a deal with private equity.
Then when you think that Paramount Pictures could demand ~$10B, the value of Simon & Schuster of ~$2B+, PlutoTV & Paramount+, the real estate, and so much more, the thesis is clear of why I have been a long term bull with Paramount.
The fact that just a sale of Showtime on its own @ $3.5B would represent 25% of the company's current equity value, further confirms the sum of parts thesis. However, what Wall St. does also know is that Shari Redstone is unlikely to sell for the next couple of years and they are skeptical of $PARA's ability to execute on their gameplan - hence the discount to intrinsic value.
As a true investor in Paramount, the idea of a Showtime sale and a massive buyback causing shorts to get flashbacks to the Bill Hwang era, would have been great. However, the long term potential of a successfully executed push into streaming by Bakish and co. could lead to even greater rewards - a gameplan that they are executing on beautifully.
In a streaming landscape where a deep library of unique IP matters critically, Showtime with YellowJackets, Billions, Homeland, Your Honor, Shameless, Dexter, and more, is extraordinarily valuable. Especially, as $PARA plans to collapse Showtime into Paramount+, the ability to drive one core product has the potential to create in my eyes a true streaming wars contender.
Also, from a strictly financial perspective valuing the Showtime asset, I think that this was a real low ball of an offer. Steven Cahill, analyst at Wells Fargo, estimated that Showtime does $2B in revenue on a $1B content budget. He assumes that there is an additional 20% of SG&A and marketing costs leaving the service with $600M in EBITDA.
This would mean that Nevins offer was just over 5x EBITDA - which I find to be a real low ball due to the thematics in streaming, Showtime's quality, and consumers insatiable appetite for great content.
I also don't think that Nevins would have went in that low for Showtime, which makes me think that the fundamentals of Showtime's business are not as strong as Cahill projects.
I also wanted to point out that if Nevins were to have acquired Showtime, I feel that this would have been the first move of two. I project Nevins would have went after the consistently shopped Starz from Lionsgate for a couple billion.
Nevins and Co. would have looked to build the premium streaming service, built it up for 3-5 years before selling it to a larger player. The gameplan was smart and clear, however, it looks like Nevins and General Atlantic did not want to pay up.
Simply put: In regards to Showtime and paramount, It is on PARA's management to unlock the value of this company. They have their strategy, it is working, and they have committed to it. At the same time, they still have so much to prove.
CHART OF THE WEEK
1. Splunk = FCF Machine
Splunk released their Q4 earnings earlier this week, and I continue to be bullish on the company. Why? As you can see from the title, they are quickly becoming a FCF machine
Splunk is projecting $775-$795M in FCF in 2024 (which is their next FY) representing 81%-86% growth YoY and ARR of $4.125B - $4.175B representing 12-13% growth YoY
From a valuation perspective, at a ~$17B market cap, the company is trading ~21x FCF and 4x ARR
Want to read more of my thoughts on $SPLK? Make sure to check out my analysis on the company from December
PORTFOLIO
The Crossover Portfolio
Note: The Crossover Portfolio is a mock portfolio of how I would be investing and not with real money. All trades are shared publicly @ The Crossover Twitter as they are recognized.
Moves: Zero moves. Just how we like it. Again!
The Zone: The Zone announced that they have become the official Mental Wellness Partner of The Big East. What a big accomplishment for Ivan & Co.
RocketVR: RocketVR was featured in the Boston Business Journal
$SPLK: Splunk released their Q4 earnings and they were rock solid. Click here for link to their investor presentation from the quarter
$ESTC: Elastic released their Q3 earnings and they were excellent!
MEME OF THE DAY
GOLDEN NUGGETS
The atmosphere at Charlotte FC's stadium looks incredible! The MLS continues to heat up
Lebron, Luka, and Mahomes in one pic. This is sweet.
WeWork's market cap is now below the value of the golden parachute that Adam Neumann received. Crazy.
This Warren Buffett quote is flames
Thanks for the read! Let me know what you thought by replying back to this email.
— Alan
Disclaimer: The Crossover is not a professional financial service. All materials released from The Crossover are for educational and entertainment purposes. The Crossover is not a replacement for a professional's opinion. Contributors to the Crossover might have positions in the equities in the The Crossover Portfolio or mentioned in the newsletter.