Shift4 Payments: Strong quarter interests me (NYSE:FOUR)

Company Overview

Shift4 Payments (NYSE:VIER) is a payment processing company that handles billions of transactions for thousands of businesses across multiple industries. They generate revenue through merchant processing fees, as well as subscriptions revenue from their software solutions. This subscription revenue makes up ~8% of FOUR’s total revenue today, compared to 12% in 2019. Despite this, subscription revenue is growing faster than payments.

Originally, FOUR focused solely on restaurant clients. However, they have done an impressive job of diversifying and now have clients in retail, hotels, sports stadiums and resorts.

Investment theory

As briefly mentioned above, one of the main reasons I like FOUR so much is that it is a small but rapidly growing software offering that includes a variety of different subscriptions such as point-of-sale (POS) software, payment devices, and business intelligence tools. Despite FOUR being a leader in niches like restaurants, only 15% of total restaurant revenue comes from the SaaS model, which is the big opportunity.

So the positive is that FOUR has an extremely broad customer base. The opportunity for the company is huge, with 125,000 restaurants in the US alone.

SkyTab is an end-to-end POS solution that combines hardware and software to streamline restaurant operations. Key features of SkyTab include tableside ordering, contactless payments, loyalty and marketing tools, cloud-based reporting, and integration with other systems, among others.

Management expected to install approximately 30,000 SkyTab systems in 2024, and in Q2 alone they managed 10,500 systems, which is a 12% QoQ increase. Therefore, they are currently far exceeding their 2024 targets, which is a very positive sign for FOUR’s gradual shift towards a SaaS company.

VIER is starting to show promising results in the restaurant sector and has great potential to extend this expertise to other sectors such as sports, e-commerce, healthcare and gaming.

The second expansion opportunity is outside the US. They are doing incredibly well in the US with thousands of new customers in the hotel, restaurant and stadium niches, but to really capitalize on the market they need to become more international. Europe is digitalizing at a rapid pace and FOUR has the opportunity to be a frontrunner in this revolution. That is why they made 2 solid acquisitions in the quarter; Revel and Vectron.

In line with many other investors, I would generally prefer not to see growth via M&A, simply because it is riskier and less organic. However, FOUR has done an incredible job with acquisitions in the past, and so this gives me a bit more confidence that management is making the right decisions.

Celebrating

I was a bit confused by this acquisition, because I don’t believe it has expanded the TAM much. Revel is an American company that provides POS systems in the restaurant and hospitality niche. Furthermore, Revel has been quite loss-making since its inception, but management expects a contribution from Revel synergies of $15,000,000 in adjusted EBITDA. I hope I am wrong, but this is a fine situation where I would rather see a bit of slower but organic growth than forced acceleration.

Vectron

Vectron is a German POS company focused on the hospitality and bakery industry. They have a very strong presence throughout Europe as one of the leading POS system providers across the continent in the hospitality niche. This acquisition makes much more sense to me as it actively helps FOUR to begin their expansion in Europe.

I think it is important to focus a lot on international expansion, but I still see a lot of opportunities for the company in its own country, especially in different sectors like sports and entertainment, where they are very proactive in closing deals.

Q2 profit

Q2 earnings were strong, hence we saw a nice reaction to August 8th earnings. Here’s a quick recap:

• FOUR generated $40 billion in end-to-end payment volume, which is up 50% year-on-year. This was again driven primarily by FOUR’s course niches; restaurants, hospitality and retail, although we did see some nice growth in stadiums and ticketing.
• While still small, we saw subscription revenue grow 93% year-over-year to $71 million in Q2. This compares to overall quarterly revenue growth of 24%.
• FOUR generated $162 million in adjusted EBITDA with a margin of 51%. Margins could have been much higher if not for the two acquisitions we discussed above. Management did indicate that they expect much more margin expansion as synergies begin to emerge through acquisitions, as well as natural operating efficiencies over time, such as with AI.
• FOUR generated $76 million in FCF, an increase of 18% year-over-year.
• Expectations were positive: turnover growth would increase by more than 25%, with a significant acceleration in Sports & Entertainment.

Other

Debt

FOUR announced a $1.1B senior notes offering at 6.75%. Many retail investors see this kind of news as a bad sign, without actually digging into the details and plans of the offering. ~50% of the offering will be used to pay down the $690M higher interest debt, which was a big bear case for the stock, so that’s a good sign. Previously, FOUR had a high debt-to-equity ratio of almost 2x, so it’s a very strong sign from management to pay down this debt that investors were worried about.

We don’t know for sure where the other half will go, but I can only assume they are strategic investments to further expand VIER TAM.

Disadvantage

The highlight of the earnings call for me was probably finding out that Shift4 currently has a backlog of $25 billion! This is the volume that has been contracted but not yet implemented. This shows that FOUR is not only winning several new clients, but also large clients. According to management, a large portion of this huge amount comes from sports stadiums and businesses that are essentially waiting for seasons to start or resorts to open. This volume should all be realized this year.

Valuation

FOUR currently trades on an NTM EV/EBITDA multiple of 9.5x and an EV/Sales multiple of 1.8x, which seems very reasonable given growth rates that are approaching 30% and still not shrinking. Here are the different trends:

As you can see, despite all the bullish catalysts coming, FOUR has traded at a pretty low valuation to its recent peak over the past 2 weeks. I still see a very significant amount of multiple expansion from these levels, especially if they continue to acquire well and fully carve out their dominant share of the niche.

When we compare this valuation to competitors, we get the following based on NTM EV/Sales:

We see a similar trend when looking at Fwd P/E, with FOUR being valued slightly higher than SQ, but significantly lower than Toast (TOST). When you consider that FOUR’s revenue growth of 29% YoY is still higher than TOST’s revenue growth of 27% YoY, these charts start to show why FOUR is so undervalued.

Risks

As briefly mentioned above, there are some clear risks with FOUR’s acquisition style of growth, and I would definitely prefer to see FOUR grow more organically. Of course, the previous acquisitions FOUR has made have been largely successful and this should give investors confidence, but there is no denying that this is a much riskier form of growth, especially in a competitive sector such as this.

The other big risk for FOUR is the non-diversification which has improved significantly, but they are still very focused on the consumer industry in restaurants and hotels. These industries are clearly more subject to volatility in line with the economy, and this will directly impact FOUR’s business.

Conclusion

All in all, there’s a lot to love about FOUR. They’re a fast-growing SaaS company that dominant their niches in the restaurant, hotel and stadium businesses. However, they still only have 15% of restaurant revenue coming from recurring SaaS business, highlighting the opportunity for this business.

If we look at it from a valuation perspective, we have a company with a growth rate of almost 30%, but an EV/Sales multiple of 1.7x, which puts it well behind competitors like TOST, which have lower revenue growth.

I don’t quite understand why the market doesn’t appreciate the opportunity for FOUR. I would assume the company is on the riskier side of the spectrum due to its acquisition-based growth model and lack of diversification at this point. However, the international expansion opportunities and SaaS potential for recurring revenue mean that FOUR deserves a much higher multiple.