FOUR - Beyond The Noise: The Bull Case For Shift4 Payments

2023-10-11 13:37:02 ET

Summary

• Shift4 Payments is an undervalued opportunity in the payments processing space with a strong growth history and robust business model.
• The company has strong network effects and offers an end-to-end solution through its integrated software and payments platform.
• Despite concerns raised by short-sellers, Shift4's momentum, upside prospects, and reasonable valuation make it an appealing investment for long-term investors.

Investment Thesis

Shift4 Payments ( FOUR ) represents an undervalued opportunity in the payments processing space with an impressive history of growth and a robust business model. While short-sellers have raised concerns about debt and alleged accounting practices, I believe Shift4 has consistently delivered strong results, addressed valid criticisms, and trades at reasonable valuations given its exciting growth trajectory. The negative noise around Shift4 appears fully priced into the stock, and long-term-oriented investors should look past these near-term issues to recognize the sizable upside potential. With its differentiated integrated software and payments platform, Shift4 is disrupting the legacy processing landscape and taking share across high-growth verticals like restaurants, hotels, stadiums, and e-commerce. The company's impressive track record, reasonable valuation, and massive addressable market together make Shift4 an appealing investment for those with a multi-year time horizon. Though not without risks, the prevailing bear thesis seems short-sighted given Shift4's momentum and upside prospects.

Strong Network Effects in Payments Processing

Shift4 is a leading independent payment processor focused on providing an end-to-end solution through its integrated software and payments platform. The company serves over 200,000 business locations across major industries like hospitality, restaurants, sports venues, and e-commerce.

A key differentiator for Shift4 is its embedded software integrations and proprietary gateway that together enable an omni-channel commerce experience for complex merchants utilizing multiple systems. Shift4 has over 500 software integrations, far more than typical processors. This allows Shift4 to meet the operational needs of merchants in a seamless fashion across in-person, online, and mobile transactions.

Shift4 has also built out a diverse portfolio of technology solutions in areas like POS systems, business intelligence tools, e-commerce capabilities, and mobile payments. These innovative offerings complement the core processing platform and drive additional value for merchants. As CEO Jared Isaacman noted on the Q4 2022 earnings call, Shift4 is successfully "lifting the intersection of payments and commerce-enabling software."

The company distributes its solutions through a large internal sales and service network as well as partnerships with independent software vendors. This distribution reach gives Shift4 extensive access to new merchants across its focus verticals.

The model produces a highly recurring, transaction-based revenue stream. Shift4's volumes and revenues have grown rapidly at a 3-year CAGR of 45% and 63%, respectively, showing the attractiveness of the company's value proposition. Shift4 has also expanded adjusted EBITDA margins from 7% in 2019 to 40% in 2022, demonstrating the operating leverage in the business. As President Taylor Lauber stated on the recent Q2 2023 call , Shift4's "balance sheet, cash generation and profitable growth has positioned us incredibly well for the current environment of uncertainty."

Arguably Shortsighted Bear Case Overlooks Long-Term Potential

Some bears like Blue Orca have raised concerns about Shift4, but I think these arguments miss the forest for the trees. On debt, while leverage is elevated, Shift4 maintains a low cost of debt and no near-term maturities. The company continues generating ample free cash flow to pay down debt, and management has reiterated its commitment to deleveraging.

Blue Orca argues Shift4 allegedly engaged in concerning financial maneuvers due to CEO Jared Isaacman's personal loans, but this appears to be fearmongering. Isaacman's borrowings in no way impact Shift4's long-term potential in my view. The CEO has not sold shares on the open market in over a year, and his loan-to-value ratio on pledged shares remains reasonable. Speculation about margin calls is just that – speculation.

Regarding accounting practices, Shift4 possibly may have pushed boundaries like many high-growth companies, but claims of manipulation go too far in my opinion. The company has addressed SEC scrutiny where warranted. For example, recent extensions of depreciation schedules are reasonable given Shift4's growth outlook. While investors should monitor accounting closely, I believe management has not evidenced intent to mislead.

Much is made of Shift4's distributor acquisitions, but the decision to bring resellers in-house provides numerous benefits. Shift4 gains pricing power, reduces customer acquisition costs, and improves service quality. The impact on gross profit is a secondary outcome, not the motivation. Distributor deals also allow Shift4 to optimize operations under a unified brand and platform.

On cash flow, the withdrawal and subsequent partial redeposit of sponsor bank funds in Q4 2022 was disclosed properly and does not constitute manipulation in my view. Shift4 simply managed working capital ahead of a new deal with improved terms. Such collateral optimization is common across payments companies.

Overall, while Shift4 exhibits flaws common among high-growth companies, claims of existential threats due to alleged financial games appear overwrought. Management has balanced growth and profitability responsibly. With reasonable valuations and massive market opportunities ahead, short-term issues raised by bears seem unlikely to impede Shift4's impressive trajectory.

Valuation

Trading at 20x forward earnings and 1.3x sales, Shift4 looks attractively priced given its growth profile. I believe as it starts becoming clear that the bearish thesis is short-term noise, the market will start to appreciate Shift4's strong underlying growth and award it with a more reasonable valuation of 2x sales. Estimating 20% revenue growth for the next 5 years and a valuation expansion to 2x sales, my 2028 estimates for FOUR are the following:

Bears miss the forest for the trees in my opinion by overemphasizing temporary issues and underappreciating Shift4's long runway for expansion. The company is successfully disrupting the legacy payments space and has only begun to scratch the surface of its potential.

Risks to Consider

While Shift4 exhibits an attractive growth profile and upside potential, investors should be clearly aware of certain risks. The company does maintain elevated leverage, even though debt servicing appears manageable. Shift4 operates in a highly competitive industry and faces rivals like Adyen (ADYEY), Stripe (STRIP), and Square (SQ) working to disrupt payments. Execution risks also exist around major initiatives like international expansion.

Shift4's accounting practices warrant close monitoring, though claims of alleged manipulation seem overstated. The company has room for improvement in financial transparency and governance. Macroeconomic uncertainty could dampen volume trends, especially in consumer discretionary sectors like restaurants that account for a large portion of Shift4's volumes currently.

While these risks do not negate Shift4's long-term upside, they do mean the investment trajectory may not be linear. Near-term fluctuations and potential drawdowns remain possibilities. Investors should size positions accordingly and closely track execution against the bullish thesis. Upside potential comes with uncertainties that merit acknowledgment.

Conclusion

Shift4 Payments has built an integrated payments model that is unique in its ability to handle the complex needs of enterprise merchants. With software and payments solutions tailored for high-growth verticals like restaurants, hospitality, stadiums, and e-commerce, Shift4's opportunities abound.

Despite legitimate but manageable concerns on leverage and accounting, the company's strong results and reasonable valuations make the stock compelling at current levels for long-term investors. Payments processing remains a dynamic industry and Shift4 is positioned as an emerging leader.

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