Toast, Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 3/5

Toast, Inc. is a cloud-based, all-in-one digital technology platform primarily serving the restaurant industry, offering solutions for point-of-sale, digital ordering, payment processing, and various back-office operations.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Toast, Inc. operates as a SaaS business within the restaurant industry. Its core offerings include a fully integrated platform that manages all restaurant operations: digital ordering, point of sale (POS) systems, payment processing, inventory management, customer loyalty, and other back-office functions. The platform serves a range of restaurant business sizes and types, including both small independent restaurants and larger chains.

### Revenue Streams Toast generates revenue primarily through:

  1. Subscription Services: Recurring revenue from subscription fees to access its software platform. These subscriptions usually span 12 or more months.
  2. Financial Technology Solutions: This revenue stream comes from payment processing services and fees for other financial technology solutions.
  3. Hardware: Revenue is generated from selling or leasing a wide variety of hardware products such as POS systems, kitchen displays, and handheld devices.
  4. Professional Services: Income generated from business planning, strategy consulting, menu management, and setup services.

Competitive Landscape

The restaurant industry is undergoing rapid digitalization, creating a highly competitive market. The competitive landscape includes legacy POS providers, specialized payment processors, online ordering platforms, and software suites with overlapping feature sets. Major competitors include companies such as Lightspeed, Oracle Hospitality, and Square.

Key competitive dynamics are:

  • Consolidation: There is a trend of industry consolidation as bigger companies acquire smaller players to gain market share and expand capabilities, such as Toast’s acquisitions of Stratix and Delphi.
  • Technological innovation: The pace of innovation in financial technology and cloud services is critical. The ability to adapt to changing customer needs, integrate new features, and develop new payment methods can be a source of competitive advantage.
  • Data-Driven Insights: Companies that can provide insights into customer behavior, operations, and revenue data may have more success in the long run.
  • Customer Acquisition: Securing a client in the restaurant industry is challenging, leading to fierce competition to get new locations on board, often involving heavy marketing and sales expenses.
  • Regulatory Environment: Payment processing is subject to various regulations; compliance is needed to avoid financial penalties.

What Makes Toast Different?

  • Integrated Platform: Toast offers an all-in-one, fully integrated platform, designed specifically for restaurants, connecting the front and back of house operations across various restaurant types.
  • Industry-Specific Solutions: The platform caters specifically to the restaurant sector, offering features tailored for their unique requirements, such as menu management, ordering and payment systems, kitchen management, delivery, and loyalty programs.
  • Multiple Service Offerings: Beyond its core POS and payment processing, Toast provides a diverse set of services including hardware, kitchen and employee management solutions.
  • Customer-Centric Focus: A focus on improving customer experience by reducing wait times, optimizing ordering processes, and delivering timely and accurate table service.
  • Open Ecosystem: Toast provides a platform for other software providers to integrate their services with it.

Financial Analysis

Toast’s financial performance is complex to interpret as they are heavily investing in the business while trying to get the business to profitability.

  • The company generates revenue through subscription services, financial technology solutions, hardware, and professional services, of which subscriptions were 42% of total revenue in FY 2023.
  • Revenue: Revenue has steadily increased year-over-year, but this growth is accompanied by increasing net losses, which is expected for growth companies.
    • Total Revenue for fiscal year 2023 increased by 29% compared to 2022, mainly driven by payment processing and subscriptions, a growth rate that was less impressive when compared to the 46.9% increase of 2022.
    • The company projects a revenue between $1.045 and $1.055 Billion for the first quarter of 2024 (33%-35% increase)
    • Revenue for the three months ended September 30, 2024 increased by 24.5% compared to the same time in 2023, which they consider a result of the growth of their core subscription products and increase in payment processing volume.
  • Margins: Gross profit has increased but gross margins are around 19%, suggesting most of their revenue comes from hardware and payment processing which inherently have low margins.
  • They aim to improve this to the target of over 30% by focusing on high-margin recurring subscription revenue, but that will take some time.
  • Net Income:
    • For the fiscal year ended December 31, 2023 net loss was $275.2 million
    • For the nine months ended September 30, 2024 net loss was $150.2 million.
  • Recurring Revenue: The majority of Toast’s revenue now comes from recurring subscription-based revenue, showing a consistent and predictable source of income.
  • Liquidity:
    • Cash and cash equivalents stood at $725.1 million as of September 30, 2024.
    • The liquidity of the business is good; they have enough cash at the moment for operations.
  • Debt:
    • Long-term debt stood at $1,098.8 million.
    • They have been raising debt to fuel growth.

Key Metrics

  • Gross payment volume (GPV): The total sales at their locations has been growing steadily, with the latest quarter showing 24% YoY growth.
  • Annual Recurring Revenue (ARR): They ended 2023 at $1.1 billion in ARR, a 28% increase YoY.
  • Net Retention Rate (NRR): NRR is good at around 120%, implying that they are selling more to their existing customers every year.

Moat Analysis

Based on the information available, Toast has a moat rating of 2/5. This rating is due to their relatively strong market position, but the increasing competitive environment and reliance on technology could weaken this in the future. Here is the detailed analysis of why:

Strengths

  • Integrated Platform: Having an all-in-one product for restaurants creates a switching costs moat. This is because, it makes a complete ecosystem for the customers, which would be very costly to change from. Restaurants would need to adopt a new POS system, new payment processing software, new inventory management, etc…which leads to operational disruption, time and expenses.
  • Industry Specialization: Since their focus is very specific to the restaurant industry, they create a better and customized experience for their customers, which leads to customer captivity.
  • Data-Driven Insights: They have access to huge quantities of restaurants’ data, such as ordering trends and best-selling dishes, and provide analytics to help them make data-driven decisions. This feature is hard to replace or copy.
  • Financial Benefits: The payment processing software makes it easier to manage payments and have faster money transactions.

Weaknesses

  • Competitive Environment: The restaurant tech industry is intensely competitive. There is a multitude of competitors and it is easy for a new player to emerge.
  • High Switching Costs Can Be Overcome: As it’s a technology business, superior technology can render them obsolete and make switching a more worthwhile endeavor for the customer.
  • Low Barriers to Entry: Although the integrated platform creates some stickiness, the barriers to entry are not high as new entrants can create similar tech and challenge the existing players.
  • Reliance on Technology: The company depends on providing a good technology experience. Any disruption on this front could negatively affect the customer base.
  • Growth is Primarily Inorganic: Most of the growth comes from newly added locations. But same store growth, which shows a more efficient value creation, is not that strong, with the company even losing some of that.

Risks to the Moat

  • Technological Disruption: Any change in tech can reduce the value of their platform as new providers come up with better solutions, leading to increased customer churn.
  • Increased Competition: The more saturated the market gets, the more the companies need to compete and lower prices, reducing their value.
  • Shifting Customer Preferences: If customers prefer to have more flexibility and prefer not to rely on a single service provider they could be likely to choose separate solutions from different providers.
  • Regulations: A change in regulations, including data protection, security and finance, may increase expenses or make business difficult to carry out.
  • Acquisition Failures: If Toast makes an acquisition which is later determined to be an inefficient purchase, it could lead to goodwill impairments and losses. Also it can affect integration and thus synergy.

Business Understandability: 3/5

Toast’s business model has some complexities, warranting a moderately difficult understandability rating. The platform’s integration of several services—hardware, software, and payment processing—requires some knowledge of the industry and its operations to grasp fully.

  1. Clear Value Proposition: On the surface, Toast provides technology to restaurants which is easy to understand.
  2. Multiple Revenue Streams: Their dependence on multiple revenue streams, ranging from subscription services to hardware, creates a less straightforward view of the financials.
  3. Complex Valuations: Intrinsic valuation is not readily available and requires understanding key metrics like gross payment volume, annual recurring revenue, and net revenue retention rate.
  4. Accounting Nuances: The financial statements can sometimes be confusing due to the accounting of various components such as software revenue recognition.

Balance Sheet Health: 3/5

Toast’s balance sheet is reasonably healthy, showing a few red flags that may pose a risk for the company’s future performance. Hence a rating of 3/5 is assigned.

  • Strong Liquidity: Their good amount of cash and marketable securities gives them short-term stability to handle their operating costs, and further pursue new opportunities.
  • High Debt Load: Debt, especially long term debt, has been increased to finance growth, but its burden can create complications for their long term profitability and viability.
  • Intangible assets: Goodwill and Intangible assets are a significant part of their balance sheet, making them vulnerable for write-downs should market conditions worsen. They have a total of $1.8 Billion, of which $1 Billion is goodwill and the remainder is intangible assets, including technology.
  • Negative Equity: The net loss and high debt have resulted in negative equity as of Q3 2024. Although most high-growth companies have negative or low equity, a business with long-term negative equity could signal an unhealthy business model.
  • High Operating Losses: High operating losses show that the business is still in its growth phase and is far from being profitable. This indicates operational risk to the business if it doesn’t stabilize.

Controversies and Problems

  • Recent CFO Change: As reported in the Q3 2024 earnings, the CFO Elena Gomez is going to step down from the CFO role, indicating a sudden change in the leadership.
  • Stock Price Decline: While the company is experiencing revenue growth, its share price is hovering at all time lows. This has brought concerns among existing shareholders and future ones.
  • Employee Layoffs: The company undertook a series of job cuts, signaling an attempt to become leaner to better profitability. This signals bad management of personnel, and a negative outlook on the business.
  • Uncertain Growth Strategy: The company appears to be relying on inorganic growth via acquisitions. While this might benefit revenue in short term, it is still uncertain if it will bring long term profitability. Also, the company’s growth seems to depend more on volume and not price increases.

Summary

Toast’s platform provides a useful service for restaurants, but they still have a lot to prove in terms of operational efficiency and financial management. Given the competitive landscape, high debt, and continuous restructuring of their organization, they are in a complex environment and should be analysed thoroughly before investing.