PAR Technology: What The Market Is Getting Wrong
Summary
- PAR's value is obscured by a complicated story and a small market cap.
- PAR includes some of its D&A expense in its cost of sales, making it harder for investors to see the margin expansion due to software.
- PAR still has many products in its pipeline (payments, order management, analytics) that could lead to accelerating growth.
- TAM is still underpenetrated, with virtually no international software business.
- The terminal value of the business is underappreciated and could be a significant driver of a price increase.
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PAR Technology (NYSE:PAR) shares are grossly undervalued due to some unwarranted concerns and the market sentiment change. However as some of these concerns are addressed in the coming months, PAR's stock will benefit, and I see a 60% upside from PAR's current value. Additionally, the possible sale of the government business and two product launches are some potential catalysts.
Market Misunderstandings
Growth Concerns
PAR's software business growth rate which is lower than some of its peers has concerned some investors. Many of PAR's comps saw their revenue growth accelerate during the pandemic, but PAR was unable to activate new customers because PAR's POS software product Brink requires an on-premise installation which was not possible during the height of the pandemic. PAR still benefited from the pandemic as it saw record bookings for Brink, but the company is only now able to convert these orders into revenue.
Additionally, PAR's customer base is very different than most of its peers who have gone after small and medium sized restaurants. Enterprise restaurants have longer sale cycles than small/medium restaurants which slows the ramp up but also makes users more sticky.
Accelerating Growth?
PAR's payment service product which will formally launch in Q4 2021 has significant traction already. PAR has onboarded Sweetgreen's (SG) 140 locations and management indicated other large customers will soon be announced. PAR Pay's early traction is very encouraging and this could be a significant and unexpected contributor to ARR growth. To a get sense of the opportunity, payment processors take between 2%-5% of payment volume per franchise agreements.
PAR Pay also enables its customers to pay for their POS hardware through their payment volume as opposed to upfront. Lower CAPEX requirements make it easier for restaurants to upgrade their POS systems which will help Brink onboard more customers.
Lastly, PAR's new digital order management product is coming out in Q1 2022 and this high-value product could help increase ARR. PAR's CEO indicated during the Q3 21 call that a "pile of customers" are already signed up which is encouraging.
Cutting through the Margin Noise
PAR's service segment which includes its software business has seen its gross margins expand, but this is obscured by PAR's unusual choice of expensing the amortization of acquired technology in its COGS. Backing out this amortization charge, service gross margins reached a record 42% in Q3 2021 versus the historic ~30%.
Despite the simple explanation, PAR's accounting policies make it harder for investors to see the margin expansion, a key driver of the bull thesis. Management began disclosing service gross margin excluding the amortization on recent conference calls and this could help clear up any confusion on the topic. The next step would be a change in accounting policies which would make the margin expansion clear just by looking at the company's financial statements.
Government Business Divestment
Investors have long wanted PAR to sell its government business which obscures PAR's revenue growth and margin profile. PAR was holding on to the business in anticipation of a record contract which PAR finally announced in early November 2021. This $490 million contract, the largest in the company's history, opens the door to a sale because it helps PAR maximize value. Management has not commented on exploring a sale, but they have confirmed that a sale was off the table until now. The sale of the government business would be a definite catalyst because it would help "clean up" PAR's story and prompt some of the big TMT desks to begin coverage.
Sum of the Parts Valuation
PAR's closet comparable is Olo, an order management software solution, trades at ~20x consensus E2022 ARR. The multiple is driven by 80% LTM gross margins and 50% historical revenue growth. PAR's growth is similar and its pipeline is more robust based on TAM penetration. Nevertheless given PAR's significantly lower margins, a 15x E2022 ARR multiple seems fair for PAR.
First off, I pegged Brink's 2022 ARR at $49 million which is based on the assumption that Brink continues to grow its site base at 35% which seems reasonable given that PAR will likely still have a ~1,000 site backlog entering 2022 (based on current activation and booking trends) and continue to sign ~1,000 new sites per quarter. Based on historical ARPU growth, I also assumed a 7.5% increase in ARPU.
Secondly, I assumed Punchh continues growing at its historical rate of 50% based on its proven ability to sign large chains, its expansion into the C-Store market, and the potential for international expansion. ARR growth will also be driven by price increases as ARPU currently stands at around $800 while new customers are onboarded at $1,000-$1,500.
I assumed a modest 10% CAGR for Data Central, PAR's back-office software product, which has been challenged in recent quarters. Despite a recent uptick due to labor shortages and rising food cost, it is still unclear how sustainable Data Central's comeback is.
Lastly, I assumed a $2.4 million of ARR for PAR's upcoming digital order management product based on a 10% adoption from Brink's customers and a $1,200 ARPU figure which is what logos are paying for similar products.
Source: Author (Based on PAR's ARR Disclosures)
Based on this, we get $134 million of ARR for 2022, and we then apply 15x ARR revenue multiple to get a $1.95 billion valuation for PAR's software business. To find the value of the remaining businesses, I'll continue to use revenue multiples because it hard to get clear EBITDA or earnings due to the unclear allocation of operating expenses.
My E2022 Revenue for the defense business is a conservative $85 million an ~18% increase from current LTM revenue based on the new contract. I believe that 1x revenue multiple is fair because of the low gross margins (~8%). I pegged the hardware business' E2022 revenue at $88 million assuming a 10% CAGR from FY2020 Rev. FY2021 Rev. is already in this $88 million range because of the backlog accumulated during the pandemic, but FY2022 Rev. is likely to reflect historical CAGR. Due to a better gross margin profile (~20%), I believe a 2x revenue multiple is warranted, valuing the segment at $176 million.
The valuation of PAR's other businesses is quite conservative as it's hard to find public comparables to value these businesses. Nevertheless, summing all three of these business gives us a total value $2.211 billion valuation, a 59% upside from the current market cap.
Terminal Economics Valuation
Multiple valuations provide us with some sense of PAR's value but most of the company's value lies in its terminal economics. The company is in the early earnings of building the only restaurant software platform (loyalty, POS, back-office, payments, digital order management etc...). As PAR executes its platform strategy, the company will offer a unique best-in-class value proposition in a large and under-penetrated TAM with competitors trailing behind.
Unique Value Proposition due to Platform Strategy
The restaurant industry is still relatively early in its digital transformation. As software enters every facet of the industry, restaurants are managing increasingly complex stacks with on average 13 applications. Technology has felt more like burden than a tool for a lot of restaurants who have been overwhelmed by some of the changes. PAR's platform will simplify the lives of operators by meeting all the needs of modern restaurants in a single and simple offering. Not having to manage multiple vendors and complex stacks will also make new tech easier to implement.
Source: PAR Technology Investor Presentation
The platform's most exciting aspect is the Pandora's box of new products made possible by an integrated stack. Today, a restaurant's data is stored in the different silos of each application, making it hard for restaurants to leverage their data Tomorrow, PAR's platform will consolidate all of a customer's data in one single platform. With all this data, PAR will be able to offer significantly more powerful tools to its customers.
For example, PAR's platform could tell restaurants what promotions to run based-off customer data and what margin or ROI they should expect based-off back-office data. Customer analytics would be much detailed as they would include data from all channels. Having access to centralized data will eventually help inform every aspect of a restaurant's operations.
Under-Penetrated Total Addressable Market
Secondly, PAR's TAM is huge and under-penetrated, and the product has a robust growth pipeline. For example, Brink is in 15,000 locations out of 700,000-800,000 QSR and Fast Casual restaurants in the United States. This represents a penetration of only ~2% of the TAM on a per store basis and this does not even take into account the addressable market internationally.
Additionally, the industry's software needs are expected to grow, and we should expect PAR to up-sell even more modules. PAR has already begun up-selling its payment processing and digital order management modules which have seen considerable traction.
Competitive Landscape and Pricing Power
The competitive landscape is currently favorable to PAR as it remains the only provider of a full cloud restaurant POS system. Most of PAR's competitors are legacy incumbents who have been slow to act. Additionally, PARs platform offering has the potential to improve PAR's competitive position. If PAR becomes the "de-facto" platform on top of which restaurants build their stacks then this makes PAR's product even more mission critical.
Companies would rather avoid at all cost a disruption and the headache associated with changing products. PAR's platform also would help the company fend off competition and technological disruption. Realistically, some of PAR's modules will at some point face competition; however, the convenience associated with a platform will make customers reluctant to churn.
Risks
Competition
The competition is fierce for large customers who often have established relationships with the incumbents. Although these companies have been slow to act they have begun improving their products to meet the needs of their customers. For example, NCR's (NCR) Aloha line is improving its cloud capabilities and beginning to embrace the idea of a holistic offering. The financial resources of these companies also pose a threat to PAR.
Public Markets
M&A is one of the main aspects of PAR's business strategy, and the company's ability going forward to access capital markets to finance its deals is an important risk. If the markets were closed to PAR this could put a lid on PAR's ability acquire other software modules for the buildout of its unified platform.
Conclusion
Based on PAR's current valuation and the company's potential terminal economics, I believe the company to be grossly undervalued. The potential sale of the government business and the performance of the new products could serve as catalysts for the stock. Investors should take advantage of the current market turmoil to enter at a low cost-basis before PAR's very exciting 2022.
This article was written by
Analyst’s Disclosure: I/we have a beneficial long position in the shares of PAR either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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Comments (26)
Listen to the podcast Invest Like the Best, he was trying to building the Berkshire of software buy acquiring small and sticky software businesses. Now he will do the same at PAR but now he has access to a lot of capital to implement his vision.
He did a good job turning around the company, making good acquisitions and changing the company culture. Next he just has to buy more software companies like Punchh and glue them together into a PaaS.
