Business Breakdowns
· 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.
· Matt Reustle
[00:00:00] S0: When you talk about the transformation of the business, particularly when you mention from 2020 to today, what stands out the most in terms of that transformation and what's happened?
· Sean Barrett
[00:00:00] S1: This business has really evolved, and at this point, it's firing on all cylinders. I think the biggest evolution that you're seeing today is the result of a ton of hard work that happened three to five years ago. So if you go back to 2020, unprofitable business, single TAM, really just focused on the core SMB restaurant customer in the US. You fast-forward to today, very profitable business, 35% EBITDA margins and growing, with five TAMs that the company has unlocked through a ton of innovation. So it started with SMB restaurants. They innovated, starting five or six years ago, building products for the enterprise, building products for grocery stores. Now they're selling into liquor stores. They've started quietly selling into gas stations. That's a new opportunity. They're selling into hotels, F&B and retail in hotels. And then they've built an international team and an international product that's already live in the UK, Ireland, Australia, and Canada, and they'll keep adding markets from there. What you had five years ago was a single TAM, highly unprofitable, hyper-growth business. Fast-forward, this business has been a 97th percentile grower for the last three years in public markets, and that's against a lot of hyper-growth semiconductor names. 97th percentile grower, while also taking margins from negative to substantially positive, while also innovating like crazy, expanding into a bunch of new markets. It's incredibly rare to find a 10X opportunity in public markets. We think we have one here just based on the current product offering.
· Matt Reustle
[00:00:00] S0: In terms of that offering and what they're doing for the customer, can you give that overview now in terms of everything that they're offering to their customer base? What's actually happening as they're selling in? What's on the other side of that offering?
· Sean Barrett
[00:00:00] S1: Toast is really the full operating system for their businesses. Think of it like Shopify for restaurants. It's the point of sale, digital ordering, payroll, automated inventory management, real-time reporting across multiple locations, and then they have complex hardware. We should get into the supply chain, but they've built a really great hardware business as well. And because it's a modern multi-tenant SaaS solution, they can code once and then deploy all the updates with new AI models and with new technologies rapidly to the whole customer base. They've got a huge data advantage that's really important as they go build new products, and that's already starting to show up in their AI offerings. And most people underestimate just how complex the customer workflow is at a restaurant. But most importantly, customers really love Toast. We do a ton of custom survey work on all our companies. Some notable takeaways as to why customers love Toast so much. Toast has a net promoter score of roughly 50, with 95% of respondents indicating they would recommend Toast. Just for reference, a net promoter score of 25 is considered really good. 30 to 50 is considered exceptional. They've got elite customer satisfaction metrics. On average, customers are using Toast for seven modules, so this isn't just a point-of-sale system like you might see with some of the competitors. It's a multi-product, mission-critical operating platform for its customers. Toast is sitting at about a 20% share of the US restaurant market with more than 160,000 locations, but they're actually winning roughly half of all new restaurant openings in the US. That's what really gets us excited. It's the definition of product-led growth that's leading to very rapid market share expansion, and the network effects in this industry have proven to be really strong over time. Usually, the top one or two players in the restaurant industry end up with 40 or 50% share. It's product-led, and they're gaining a lot of share on the back of the innovations that they made over the last five or ten years.