PAR - PAR Technology Likely Has Further To Run

2023-06-23 17:39:40 ET

Summary

• A long-time favorite as the company is a reliable performer with steadily increasing ARR.
• The company is growing into a substantial market position on the basis of multiple growth vectors.
• Finances will significantly improve through revenue growth, margin expansion, and operating leverage.
• The shares trade on a low ARR multiple.

PAR Technology ( PAR ) is one of our favorite companies as it has top-notch software solutions for the restaurant business that produce reliable 20%+ ARR growth, as well as a POS hardware business that has turned profitable and is quite complementary to its software business.

The company also has a legacy government business that has been on a tear lately and is likely to be sold at some point. It reports its restaurant software in three segments:

• Guest Engagement (Punchh and MENU)
• Operator Solutions (Brink POS, PAR Pay, and PAR Payment Services)
• Back Office (Data Central)

Only Punchh (its loyalty program solution) is feeling the slowdown in the economy a little, but it is already stabilizing ahead of management expectations and is winning back customers it previously lost ( Q1CC ):

we signed some return customers, customers who for whatever reason had in previous years churn and are now re-signing with Punchh as they have realized Punchh is best-in-class. We are also having success upselling additional Punchh modules to existing customers as they build out their loyalty and customer engagement priorities.

On the other hand, Back Office is recovering nicely with a 30% growth, and MENU has been introduced in the US market well ahead of schedule, achieving 500+ locations before any real sales effort. Some of Payment slipped into Q2.

We see numerous reasons to be bullish on the shares:

• State-of-the-art unified solution
• Increasing TAM
• Multiple cross-selling and upselling opportunities
• Operational leverage
• The possibility of a sale of its government business
• Reasonable valuation

Unified Experience

The company has state-of-the-art solutions, especially with Brink and MENU, which it is starting to sell in the US ahead of time (this was supposed to be an H2 effort) as customers clamor for it (they already sold 500 locations before any serious sales effort).

But the real advantage is that the whole is bigger than the sum of the parts (Q1CC):

While the term unified commerce has become increasingly commoditized by our mostly single product competitors, our multi-product offering gives PAR a strategic advantage. Innovation requires coordination, and optimal coordination requires control. Unlike competitors, we are able to sync multi-quarter roadmaps between products on all sides of an integration and thereby dictate quality and unlock operational efficiencies such as singular contracts, singular account management, better SLAs and more. Ultimately, what we offer is seamlessness and a unified experience that is scalable.

At the core, the company is in the customer data business, and this works much better when these are integrated in the cloud on an interconnected platform. This opens up all kinds of opportunities for analytics and AI (Q1CC):

PAR makes these analytical insights and data available to our customers in a variety of ways. Customers can perform self-service analytics right in the product itself, including campaign performance analytics, employee and business reporting and guest analytics. Customers can export this data on demand for their own self-analysis and visualization. For advanced analytics, we also provide an automated ECL of raw data into their own environments through a data pipeline. This data culture sets up nicely for the wave of artificial intelligence entering our world.

AI is still in the infancy of the restaurant business but has potential in three fields; making restaurant visits more consistent and predictable, improving the speed of service, and improving order accuracy. But management believes PAR is well-placed here due to its unified solution (Q1CC):

We believe PAR's core advantage is that we are the only enterprise firm with the data across customer identity, transaction, menu and COGS.

Management is already in conversation with its enterprise customers about an aggressive roadmap of new products, including AI.

TAM Growth

The series of acquisitions (like Punchh and MENU) and their internal development of a payment solution, as well as entering the table service segment, all conspire to increase the TAM.

But there is something else going on, big chains are increasingly seeing the benefit of the cloud in general and the seamless unified experience that PAR offers in particular as attractive (Q1CC):

With the recent wins in table service and significant strength in our new customer pipeline, Brink is positioned well to continue scaling. The table service momentum is real and the first two deals I mentioned on the Q4 call are gearing up for launches at the very end of this year and into '24... And today what we see is this, this, this pipeline fill up with, you know, very, very substantial brands that I would have thought would be the late adopters.

It remains to be seen how many of these big brands in the pipeline they can convert into customers, but they appear to be warming to the cloud, seeing the success of, and becoming aware of, the limitations of internal solutions.

Cross-Selling

While net store additions are the largest source of revenue growth, management sees a huge opportunity in cross-selling and up-selling (Q1CC):

We have a long way to go on the cross-sell and upsell within our organization. In fact, I think it's the singular, most exciting and biggest opportunity we have is that the average brand customer has two to three modules. So that's the average. So usually a Brink customer on average has at least one of our other products. But we need to really take that into three, four or five products now. And it's clear that Brink is the land and expand product for us. But the amount of under penetration is enormous.

While Payments is attached to 80% of new Brink deals but just 10%-15% of existing customers use Payments, there is a world to win here, and less than 50% of Brink customers use Data Central.

There is also some initial success in upselling additional Punchh modules to existing customers. Or take into consideration that there are 70K stores where Punchh is deployed and where MENU would be a very nice fit.

Management also noted that the climate for M&A has greatly improved, with valuations plunging (Q1CC):

And what I think is interesting is that I believe we will have outperformance as an organization and as a result have a better multiple than the deals we're looking at.

It's also useful to know that when they upsell or cross-sell, they're almost always displacing a competitor.

Finances

Revenues are steadily climbing, the multiple quarters with 40%+ growth were boosted by acquisitions, but organic growth is well north of 20%:

• ARR +23% to $116M
• Operator Solutions +27%, Guest Engagement +18% Back Office +30%
• Professional Services +10.8% to $13.8M
• Subscription service revenue was $28M (+31.4%)
• Hardware revenue was $26.8 (+$1.7M)
• Government business +48.6% to $31.9M
• Government business backlog +66% to $324M (funded backlog +105% to $86M)
• Cash used in operations was $16.7M million versus $21.2M for Q1/22

The company still makes substantial losses and Q1 suffered a bit of a decline in (GAAP) gross margins:

However, with the inexorable rise in ARR gross margins should creep up (non-GAAP subscription margin is 71%), and the rise in gross margin will likely resume shortly (Q1CC):

Our rate of acceleration of continued margin improvement slowed this quarter as we absorbed the initial growth of PAR payment services and MENU which are both in early stage products... the margins of Punchh, Data Central and Brink are all relatively high, not all the same, but all very high. And so as menu and payments scale, it'll bring the gross margin up because the rest of them all are relatively high.

Selling off the government business would boost gross margins as well as the margins there are just 7.2%. Their hardware margins (16.4%) would have been over 20% but for an inventory charge.

While OpEx still rose significantly (by $8.6M to $42.3M y/y), some of it ($1.5M) was due to the acquisition of MENU, and $5.2M was related to a reduction in the fair value of the contingent consideration liability for the MENU acquisition. The important point is this though (Q1CC):

adjusting for one-time items such as severance, this growth came with no increase to operating expenses from Q4 2022... for the past several quarters, we've been able to grow revenue and IRR while not increasing overhead while adjusting for one-time items such as severance and inventory adjustments.

Management argues it will hold operating costs flat for the year, and they made a great start with R&D (the biggest item in OpEx) down sequentially. This should provide great operating leverage.

Valuation

Fully diluted, the company has a market cap of just under $1B, but ARR could reach $140-$150M this year alone. Last year it was just 27.4% of revenue with hardware (32.2%), professional services (14.2%) and Government business (26.3%) providing most of the revenues.

Even abstracting from 70% of revenue, that is, pretending that the company only produces ARR revenues, the sales multiple is just 6. That's clearly too low, here is Adam Wyden from ADW Capital (Q1CC):

When you joined on the company, it was subscription revenue of 7 million. Whether we finished the year at 140 or 150, government is bigger, hardware is now profitable. But the company arguably trades at the lowest. Multiple private equity firms are out there buying different businesses, you know, 20%, 25% growers, 30% growers at double digit revenue multiples... there seems to be a very large dichotomy between sort of what private market value is for an asset like this or strategic market value and where you're trading.

His suggestion was to take the company private, but we think that as long as the company keeps executing as it has, investors will see the light one day and put a higher multiple on the business.

While they have a great unified business and complementary hardware POS business as well deserved to higher multiples, what obscures the view somewhat is the fact that the company isn't profitable and has a large unrelated legacy business.

With ongoing 20%+ revenue growth, rising gross margins, and operating leverage kicking in, I believe profitability will come in sight fairly soon and given the boom in the government business, it would be an opportune moment to sell that.

Risk

We see this as a low-risk stock, even with the company still quite far from profitability. It has a track record of steady and substantial increases in ARR and is cementing its position in the industry with steady improvements to its SaaS product. If anything, it's improving its competitive position, rather than facing increasing threats.

The type of restaurants it serves tends to maintain or even improve sales during a recession. Should things go badly, which we don't expect as the company was even able to survive the pandemic unharmed, it can always sell its government business, which is booming at the moment.

Cash is the obvious risk:

But it is improving and growth and operating leverage will improve it further this year in my view. Besides, the company still has $89.4M in cash and equivalents on the books (excluding the $7.4M held for customers).

Conclusion

This is one of our favorite stocks, and we were lucky to be able to pick up the stock for $25 on the selloff post earnings. There is enough to like even at present levels, though. The company keeps activating new sites as regularly as clockwork, suffers from very little attrition (<4%) has continually added modules and features that increase the ARPU, and has a large runway in terms of cross-selling and up-selling opportunities.

Its unified solution software platform is state of the art and with larger chains now developing a taste for the cloud there are ample opportunities to gain new customers, the company has also recently entered the table service segment.

With ARR inexorably rising at 20%+ ARPU on an upward trend through adding solutions and cross-selling, gross margin expansion, and operating leverage, the finances should steadily increase and profitability will come in sight.

The company can give its balance sheet a big boost by selling its booming government business as well, should it choose to do so. The shares trade at a low multiple, just the ARR can reach $150M this year with the total market cap under $1B.

For further details see: