Business Breakdowns
· Matt Reustle
[00:00:00] S0: This is Matt Reustle, and today, we are breaking down Toast. My guest is Sean Barrett, founder and CIO at Counter Global. Counter Global manages a concentrated portfolio of businesses in developed markets. And you may recall Sean from an episode last year where we spoke about a name in the alternative asset manager space, EQT. Today, we are here to cover a business in a completely different industry, and that is Toast. It's a wide-ranging discussion. I think a lot of people are wondering what software names are particularly interesting in this moment in time, and Sean gets into that and much, much more. So please enjoy this episode. All right, Sean, it is great to have you back. Today, we are talking about Toast, which is a name that we previously covered, and we do like to revisit names when there are noteworthy things going on. Maybe the story's changed a little bit, and I think we'll get into some of that here. But maybe we could just start off with a simple introduction to Toast for those that aren't familiar and your own history with this business and what brought you to it, some of those dynamics just to set the stage.
· Sean Barrett, Matt Reustle
[00:00:00] S1: Matt, great to see you. Thanks so much for having me back. Very excited to talk about Toast today with you. It's just a phenomenal business. It's a 15% position for us at Counter Global, so it's also a high conviction name. But for those in the audience who don't know about it, Toast is really the category killer for F&B point of sale and software, and they're the operating system for their restaurant customers. Super mission-critical, super innovative category killer. I've had a long history with Toast. I first invested in the business back in 2020 during COVID, and I remember the management team sent me the model, and I opened it up, and I looked at it, and I said, "This can't be right. These numbers are too good. Retention's too high for the restaurant industry. I think I'm missing something here." And I called them and I said that, and their response was, "Nope, you're not missing anything. These are the numbers." Look, it was a great business back then. I think it's an even better business now. Super excited to break it down with you today. [00:00:00] S0: I think you got into some of the words which make it thematically very interesting, which we'll get into. But maybe fast-forward to today, and you could set the stage just in terms of the financials of the business, just a snapshot or overview about where they are today. Any comparison to where they were in 2020 and how much the dynamics have changed? I'm just curious if you could share that as well.
· Sean Barrett, Matt Reustle
[00:00:00] S1: Oh my gosh, yeah, the business has changed a ton in the last five or six years. Today, it's about a $12 billion enterprise value. There is some accounting noise in there, so when you open the 10-K, you'll see that they have to account for interchange revenue as their own. But if you parse through that noise, the business does about $2 billion of recurring gross profit with about 35% EBITDA margins, minimal CapEx, really high customer retention, as we mentioned, on both a gross and net basis. It's night and day from 2020. In 2020 and 2021, they were in hypergrowth stage. Even as a public company in the early days, EBITDA margins were substantially negative. Stock-based comp was really high at 30-plus percent of revenue. Today, you have a company that is still growing very, very quickly, 25-plus percent gross profit growth. We think that can continue for a bunch of years, but it has high quality of earnings. And so we're looking at 18 times next year's GAAP PE right now. We'll get into the valuation at some point, but 18 times next year's GAAP PE for a durable 20-plus percent revenue compounder and 30-plus percent EPS compounder. So it's a phenomenal business, and it's remarkably cheap at this point. [00:00:00] S0: On the $2 billion in reoccurring gross profit, I would've assumed this is a transaction-based business. When you mention recurring, is that just a floor level, or is it truly recurring in nature with some type of contractual basis?
· Matt Reustle, Sean Barrett
[00:00:00] S0: On the $2 billion in reoccurring gross profit, I would've assumed this is a transaction-based business. When you mention recurring, is that just a floor level, or is it truly recurring in nature with some type of contractual basis? [00:00:00] S1: I think that's a good thing to touch on. When the company describes its gross profit as recurring, I think it's reoccurring in nature. So something like two-thirds of the gross profit is gonna be from payments where they get a net take rate. That's how they monetize. Even though the customers on average are using seven modules, they monetize through payments gross profit. That's about two-thirds of the business, and then software gross profit is about a third of the business. It is reoccurring in nature in that if the customers turn off Toast, they can't run their business. The retention rates are tremendously high. And then payments are a funny thing as far as being recurring in nature. They're definitely more volatile than a contract-based business, but they also grow with inflation, they grow with GDP, and it's really aligned with the customer, where their revenue becomes your revenue as well.
· Sean Barrett, Matt Reustle
[00:00:00] S1: I think that's a good thing to touch on. When the company describes its gross profit as recurring, I think it's reoccurring in nature. So something like two-thirds of the gross profit is gonna be from payments where they get a net take rate. That's how they monetize. Even though the customers on average are using seven modules, they monetize through payments gross profit. That's about two-thirds of the business, and then software gross profit is about a third of the business. It is reoccurring in nature in that if the customers turn off Toast, they can't run their business. The retention rates are tremendously high. And then payments are a funny thing as far as being recurring in nature. They're definitely more volatile than a contract-based business, but they also grow with inflation, they grow with GDP, and it's really aligned with the customer, where their revenue becomes your revenue as well. [00:00:00] S0: There's a lot of nuance to these phrases or words and semantics, but it is helpful to understand exactly where that's coming from. And then I guess just in terms of revisiting it today, hearing the 18 times next year's GAAP earnings is surprising for a number when you reference those growth rates. But what else would you mention just in terms of where we are today and why it's worth bringing up and talking about?
· Sean Barrett
[00:00:00] S1: I think the business has really evolved in a way that makes it more attractive today even than it was a few years ago. But then I think from a valuation perspective, no surprise to you, there's been a pretty severe debate in public markets around the SaaSpocalypse, SaaS is dead narrative. While we think there is a lot of disruption out there in the software space, particularly around coding and DevOps in some cases, there are also a handful of category killers, vertical market winners, and infrastructure software companies that are thriving and in a better spot now because of AI than they were a few years ago. But it's important to touch on the SaaSpocalypse debate because we aren't blind to this. There's a real transformation in the market with AI. But when it comes to vertical market multi-tenant SaaS category killers, this actually rhymes with the movie that we lived through in 2015, and I think we should talk about it for a minute. If you go back to 2014 or 2015, open source had been around for a long time, but AWS started putting open source software on its platform, and it became available to the masses. Pretty much immediately, public company software multiples collapsed to three or four times revenue, basically where they are today. Everyone started asking the question, why would anyone pay for software when we have these free open source models on AWS? Sounds pretty familiar. That was a tough time to be a software investor in public markets. It took about 18 months, and when you fast-forward to early 2016, the category killers kept putting up numbers. They kept innovating. Some of them were using open source internally, most of them were, and the stocks went parabolic. There are some differences today, no question, but it rhymes with history, and I think at this point, we feel like we have a generational opportunity to invest in something like Toast, 25-plus percent compounder, category killer at a GAAP net income multiple.