Chit Chat Stocks - Toast (TOST) | Not So Deep Dive

Episode Date: October 19, 2021

Toast Incorporated is a cloud-based end-to-end technology platform built for the restaurant community. The company provides management and point of sale systems. Toast is used in more than 48,000 restaurants. Listen closely as Brad, Brett, and Ryan go through the history, financials, and future prospects of Toast. Enjoy the show! Our Tuesday Not So Deep Dives are sponsored by Potential Multibaggers. Multis are looking for stocks that have the potential to go up 10x in 10 years. Check-out the service here: https://seekingalpha.com/checkout?service_id=mp_1308 Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Subscribe to 7investing with the code "CCM" and get $10 off: https://7investing.com/subscribe/aff/4/ Interested in more of Brad’s work? Find his Substack: https://stockmarketnerd.substack.com/ Rather watch us on video? Subscribe to our YouTube channel: https://www.youtube.com/channel/UCG5Ni-SI-jyrEsoNUhqftNQ Contact us: [e-mail] Timestamps Company Background | (3:44) Industry | (7:55) Management & Ownership | (9:27) Valuation | (12:27) Earnings | (13:30) Balance Sheet | (16:07) Our Analysis | (18:45) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, host Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or recommendation. Now, please enjoy this episode. Welcome in. This is the Tuesday Not So Deep Dive episode on Chitchat Money. We're talking toast today. Recent IPO. A little spoiler, this may be the most expensive stock we've ever talked

about. We talked about Doximity. That was pretty expensive. There goes half our listeners. Well, no. I think some people like expensive stocks, so we're going to talk about the business. It's still a fascinating one brad you chose this have you experienced toast before and why did you pick it for this episode no so we we did a show on um olo a few months back and i ended up doing a long write-up on it and um entering a position i've been adding to it so um the curiosity really just came from wanting to understand the competitive landscape in a more holistic manner and and toast is certainly not not a direct overlap to olo pretty pretty little overlap but there is some overlap to talk about so so um that that that's how that motivated that decision um to do toast

right and if you're and now let me try to get some listeners back if you're interested in square if you're interested in uh i never know how to say it fizzer pfizer uh which owns clover and if you're interested in olo this is a toast kind of compete with them and we'll kind of discuss that more and i'm gonna let ryan introduce the company but first i need to talk about our sponsor for tuesday not so deep guys potential multi beggars the aim of the potential multi beggars service is to find stocks that can go up 10x over the next 10 years or compound at 26 per year and potential multi-baggers track record has been stellar so far you've heard us talk about their picks octa at 64 a share square at 75 a share they have at the time of this writing a long list of picks uh

but there's only there was only 23 and i think there's probably slightly more now probably, you know, yeah, I'm just guessing. I don't know for sure, but you know, Chris is just awesome. We've had him on the show before and he always is keeping up with the community writing about all this stuff. Brad, did you have something to add to or no? Yeah. Just, just to, just to continue praising Chris a little bit, you know, FinTwit is a very loud, noisy, scary, intimidating place sometimes. And he's just a very calm, cool, collected voice within all of this, within all of that I just, no matter, I mean, he has mastered the divorce, the stock performance from company performance. And I really identify with that and respect his work. You know, I think I know why

he's less in the weeds on Twitter. And so kind of always level-headed it's because he's on the European time zone. He's got a total advantage because they don't have to get all warped up into the stock market hours over here. I'm telling you. I take it all back. Yeah. It's a long-term advantage for Chris, if you're listening. Yeah, we love your service. There are several portfolios each month. Chris shows what he would add and build to a portfolio over time. So it's not just one pick, set it and forget it. There's tons of stuff, but let's wrap things up. If you want to become a multi, you can go to Seeking Alpha and look for From Growth to Value. Google it. You'll find it there or go to at From Value, no capitalizations on Twitter. All right, Ryan,

you want to introduce Toast? Yeah, so I'll go. I'm just going to read the first line of their S1. Toast is a cloud-based end-to-end technology platform purpose-built for the entire restaurant community. All right. It is what most people know it as is probably just a restaurant point of sale system. They are a point of, like, think of the Square Cellar ecosystem, except this is catered really towards just restaurants, at least for the time being. And so the value really isn't on the customer side.

The value is on the restaurant side where there's sort of this back-end suite of software solutions designed to help operate the restaurant. And so they categorize the whole platform into three different sectors. So there's subscription services, financial technology solutions, and platform services. So the subscription services include point of sale, restaurant operations, digital ordering and delivery, marketing and loyalty, and team management. There are a whole bunch. I'm not going to get into every single one, but there are a whole bunch of basically different solutions on the backend that a restaurant can use, whether it's to manage like a team hours, uh, have marketing programs with returning customers or anything

like that. Um, and then the financial technology solutions, this is the integrated payment processing and financial technology products, financial technology products includes financing solutions. And I believe a loan solution where let's say you need whatever, $10,000 to get through whatever they were doing working capital loans uh and i was reading the s1 i was like okay that's interesting very similar to square capital all the other ones like this that's kind of cool however they had a disclosure that it's less than one percent or only one percent of financial technology revenue right now so it's tiny okay even if they're hyping that up and then the last one is platform services so this includes reporting and analytics e-commerce and their api partner

ecosystem they also have a bunch of there's like these are even bigger groupings of different solutions that are within them so there's different like message when your order's ready like just more these things are really comprehensive and it really helps an entire restaurant operate and so the other thing the api slash partner ecosystem that's to help build all the technology solutions into a single place because they said that was the big hiccup when they first started, and this will lead into my history, was a lot of the restaurants that they went to, the operators would say, we were up till 1am calling or trying to get our systems figured out with our eight different technology providers. So we just want it to be all in one place. And

that's really what you can do with the Toast operating system or the Toast POS, which is not piece of shit. It's a point of sales. But a little more about the history, I guess. The idea for Toast was originally conceived over a meal at a local restaurant. I don't know. That sounds a little too perfect. By Steve Fredette, Aman Narang, and Jonathan Graham. Sorry if I'm getting the middle name wrong. But the three of them met as employees at another software company. That company was eventually acquired by Oracle. So they left to start their own thing. And when they started, they asked, how do we build a mobile app that can streamline the payment experience at restaurants. Apparently the first attempt was just a plain mobile app and it failed miserably

according to the founder's letter. And so they kind of had to restart from square one and they went to restaurants and said, and just basically went door to door asking, what do you need to kind of help? What kind of technology solution? What are your problems? And so they kind of did that boots on the ground type research and that helped them move away from just purely a mobile app to a full point of sale system that connects all those different technology solutions that I talked about. And then that was ultimately what they decided to go with. They added restaurants one at a time, trying to grow their customer base today. It's 48,000 locations, which is pretty big. Maybe I miswrote something now. It's 48. I had 47 or is it whatever, something around there.

On the S1, it said 48,000. Okay. I must've rounded down or something. But they've had lots of funding rounds as well. They went public in September of this year. So they're brand new to the public markets. I don't even think they've had a public quarter yet. Yeah, less than a month, I think. Yeah, it had to be. Our LA industry landscape competition, very simple here, very easy to understand. There are 860,000 restaurants in the United States. And according to this one, they estimate there are 22 million worldwide. I don't have any TAM numbers, but you can really extrapolate very easily their realistic opportunity from the 48,000 locations they are serving right now. Unless they come up with new business lines,

it's not like they're going to have different restaurants that are doing, it's not like they started with all the restaurants that have minimal dollars flowing through there. On average, they're going to have the same dollars flowing through there. So it's going to be similar. Competitors, like we said before, Square, Clover, Par Technologies, OO, some of them are competing in just small parts of that business. The main competitors would probably be Square and Clover, I would think, because the point of sale solution is the most important part of this business right now, Ryan, you have something? I'd even go on to say that within the Square seller ecosystem, there is one, there are, or there's a set of solutions called Square for restaurants. So

that's probably like a more focused competitor within it. Yeah. And I guess Wix has something with that too. Although as someone who knows Wix well, that is a tiny part of their business. Other competitors though, I would include anyone that is doing management software, any sort of software technology for restaurants, because the whole thing like Ryan was outlining is they want any sort of technology solution a restaurant would want or need, they want to offer that. So even something like QuickBooks, back office stuff, HR, payroll processing, any sort of that stuff, they're competing with them as well. All right, Brad, do you want to hit the management and ownership of this business?

Yeah, let's do it. So Chris Camperotto is the current CEO. He was hired in 2015 and he previously, interestingly came from the world of consulting with Acquia and Endica. And as Ryan just very recently told me, all three co-founders came from that consulting firm. So there's a little bit of a connection there. But Stephan Ferdet is currently a co-president and one of the co-founders of the company. He was the CEO from 2011 to 2015 before he became just a co-president and took a little bit more of a backseat. He's held, and I quote, various roles at Oracle, nothing too specific there, but relevant experience for sure. Elena Gomez is, I would say, the superstar of the group. She's been the CFO since May 2021. She came from Zendesk as the former CFO there. She's a senior

VP of finance and strategy and go-to-market development at Salesforce. And she has a board seat with Smartsheet and PagerDuty. So really, really impressive stuff. Aman Narang is the other co-founder. He's still on board as the COO. He's been the COO since June of 2021. So very, very recent transition there. He was a previous and current board member. So just an interesting note, these executives have moved in and shaken their way into board seats and out of board seats multiple times. Not a red flag, but just something I found kind of interesting. He was a product manager at Oracle before embarking on this Toast project. The most notable board of director member is a former CFO of Salesforce and Autodesk. Shout out Autodesk for

the Chit Chat Money team. There we go. And then so after the offering ownership data, fortunately, they amended their S1 to give us more accurate information. So none of these insiders have any class A shares at all. When they convert their class B shares or sell them, they'll be converted to class A shares and then subsequently sold. So Comparado has 2.28% of Class B shares and 2.27% of the voting power, just to give you an idea of how predominantly aggregated the voting power is within Class B. So moving on from that, the co-founders together own about 12% of the combined voting power and then all executives on their own own about 15%. So that the ownership is really between insiders,

it's the two co-founders and it's Comparado. Moving on to some notable funds. These are all pre-IPO funds that were on board before the company went public. And we know that because their entire stake is also class B. But the pre-IPO funds such as Bessemer Venture Partners, and there are others that I didn't really recognize the name of, own roughly 53% of the class B voting power. No, yeah, that's a great overview. And I think Gomez was probably brought on to get ready for the IPO, wouldn't you think? They kind of were redoing this executive team to get ready for the public markets. I don't know for sure, but that would make a lot of sense. Right. And I'll hit valuation. Going to keep this one simple. Market cap is $27.3 billion. Ticker

is T-O-S-T. Pretty simple. But trailing 12-month gross profit is 107. 12-month gross profit multiple multiple yeah multiple price to gross profit trailing 12 month price to gross profit of 107 i'm actually remembering now global e online which i think we did with you brad was at 200 times so this is not the most expensive stock we've ever done but i think it takes the cake for number two however there is also 61.9 million stock options outstanding on 500 million shares so dilution is going to come in pretty heavy over the next few years unless the stock totally tanks uh and 88 of the shares are currently in lockup so over the next six months of the ipo that this is the type of scenario that can make the stock trade very wildly the valuation feels a

bit um you know artificial in something like this we'll probably discuss this more in the second half but ryan do you want to hit earnings yeah they uh all hit 2020 earnings and then they've had the last six months uh as a private company as well so they added that but they had 820 million dollars 823 million in 2020 revenue that was growing 24 versus the prior year however the last six month revenue so the the most recent six months revenue was growing at 105 percent year-over-year so there was clearly a slowdown during covid which shouldn't come as much of a surprise however out of that there was a lot of adoption from companies that used to or restaurants that used to rely on legacy systems um the 2020 gross margin was 17 shocking that that caught me

off guard because the first line had them as a software as a service company. And that's not something that typically goes hand in hand with a software as a service company. But that's why I think gross profit multiples are probably the more important proxy than revenue here. And then in 2019, gross margin was a little over 9%. So it is improving. And actually, it was 22% in the most recent six months. So from 2019 to the most recent six months, they've got 13 percentage points of gross margin improvement. That's really solid. It looks like they are starting to demonstrate some of the operating leverage that might be in the business. They have pretty large operating losses right now though. So there isn't really any gap profitability metrics to look at. And any

metrics that I point out would just be belaboring over unprofitability. Right now, they obviously, they're reinvesting heavily, which they should. And so, however, latest six months, they did generate almost $40 million in free cash flow, which was about 5.5% free cash flow margin. Granted, there was a lot of stock-based compensation, which actually was more significant than free cash flow. So if you add that back, there was no free cash flow. But yeah, I guess some of the other positive points, they have a net revenue retention rate above 110% for each year since 2015. So it seems like the customers are locking in, at least the ones that stay around. Do you want to explain what that is briefly, just in case any listeners don't know?

I'm not sure if they changed the definition or changed how they defined it, but it's just revenue from existing customers year over year. So if they took the customer base that existed in 2018, how much revenue were they generating from that customer in 2019 on average? And then, so it's basically a 10% improvement across their existing customers. And that doesn't even include any new customers. I mean, basically getting that definition, right? That is correct. Yeah. Sometimes the definition is going to include churn and sometimes they can't, but in general, it's revenue growth from existing customers. All right, Brad, do you want to hit balance sheet and liquidity? Yeah, just just focusing or just zoning in on that net revenue retention rate at 110%. That that was that was also kind of surprisingly low for me, at least some of these really high growth companies that are just developing market share. I mean, all of those is above 120%. I'm just thinking of other software companies in my

portfolio that are above 130%. So 110% sounds like a really gaudy number. It was just a little bit low for me that they're only realizing 10% more per location or per client. But that maybe just hints at the fact that their clients aren't really adding locations because they're small businesses. So just something to keep an eye on. I'll stop ranting about that. But balance sheet and liquidity. So they raised $800 million from the IPO. Proforma cash is about $1.1 billion, or Proforma cash in equivalence, I should say, is $1.1 billion. So they had some long-term debt on the balance sheet before the IPO. They did take a $50 million debt extinguishment charge to settle all of these convertible notes. And it looks like the $176 million in long-term debt that

they had was paid off right around the time of the IPO. So there was a $12 million interest expense from the first six months of 2021. But we have to keep in mind that it just took this charge for extinguishing the debt. It wiped off this long-term debt off the balance sheet, according to its most recent financial statement. So it looks like that interest expense is going to go down to zero, At least theoretically, they do have $330 million available in a senior credit facility that remains untapped. There's a couple hundred million in additional warrants. But considering the enterprise value, it's really not anything to focus on.

It has, this isn't, as we've kind of highlighted, this is not the most profitable software company, early young software company we've done. So it has leaned pretty heavily on convertible notes to finance a lot of this growth. It hasn't really been able to lean on positive free cash flow aside from a bump from really aggressive stock-based compensation in connection with the IPO to fund these operations. So the balance sheet is in good shape now with that cash raise, which was really important for them. But anytime there's a company that's burning through cash, again, without the stock-based

compensation benefit, it is something to focus on a little bit more. That's a good overview of the balance sheet. All right, let's hit the ad break. and we'll get back for the second half of the show. This episode is brought to you by La Quinta by Wyndham. Here you are miles from home and ready to start your vacation. Good thing you're staying at La Quinta by Wyndham.

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Wi-Fi app. Restrictions apply. Okay, welcome back. Next up, let's do some anecdotal evidence. Brad, we'll start out with you. Yeah, I've never noticed a toast logo in a restaurant or anything. I'm sure it's just because I wasn't paying close enough attention. But I mean, I have noticed Square's POS system a lot. So I don't know. No anecdotal evidence for me. All right, Ryan. Yeah, I've definitely i've seen some i think everyone's if you're a restaurant goer in america you've probably come across one at least at some point the i don't have any valuable anecdotal evidence because pretty much all the values on the restaurant side the customer interface is probably pretty uniform across all these point of sale systems yeah that's the same with me

i've seen it it seems fine it works well um i don't know the point of sale part is a commodity so it's kind of hard to tell. I'd love to ask, if I were interested, I would ask restaurant operators how they feel about it. I'd probably be that annoying investor that goes into a restaurant and be like, Oh, you know, what do you think about toast or whatever? But it's useful information. Like if it really helps them out and there's some sort of value differentiator on that side, that's obviously pretty important. Yeah. All right. Let's move on to future growth opportunities. Brad, what do you have for us? Yeah. So I'm actually borrowing the future opportunity that I used when we did our OLO episode. So when I think on-demand commerce and

heightening the quality and the efficiency of that process, I think of cannabis wholeheartedly and the 20% compound annual growth rate we're going to see for the next decade and the tens of billions of dollars that states are already doing in legal sales. It just seems like to me, and I interviewed with Noel Glass a couple of weeks ago and he was pretty hesitant when I brought this up. Maybe this is a little misguided, but I really think cannabis for these companies is a very natural extension for their business, especially considering the current technology solutions that exist here absolutely stink. They're not good. They're not intuitive. They're not slick. A company like Toast coming in and taking advantage of the low-hanging fruit here

makes a lot of sense to me yeah i wonder what so they talk about how their focus on restaurants is an advantage but i wonder if they're limiting themselves by not saying okay we can go to cannabis we go to uh not grocery stores but something like a you know liquor store something would work wells too i mean cannabis would definitely it seems like it's very similar maybe even simpler we might be underestimating some of the social friction in switching to cannabis also from maybe an investment standpoint uh like that can sometimes be bad for an investor based i think i i don't know i wouldn't really think about that what about all i mean it's possible but if you are a shareholder and they chose to go this route

as a new business are concerned no i would be i would be pleased i don't know brad what do you think about that? I just, I mean, I'm maybe not the best person to ask you just because I'm more, maybe more comfortable with this space than a lot of other people. So I'm not sure. I don't know, Ryan, do you want to move to your future growth opportunity? Sure. The, yeah. I mean, most of the stuff that would help them grow, they've already sort of done, I think selling more, more of their solutions, more of the restaurant solutions is pretty much the main growth driver and that's going to drive sort of the net revenue retention rate over time. But the one that I have here is acquisitions and more specifically using stock

to make these acquisitions. They actually mentioned not using stock, but they mentioned acquisitions in their S1, which I found a little bit surprising. They said, we intend to selectively explore inorganic product and technology growth opportunities to build out our portfolio and strengthen our ecosystem advantage i i thought honestly just using stock and acquire olo double the price they do double the price i'm all this market cap if yeah it seems toast i think even if you ask the executives today they'd probably assume this is a very richly valued uh price why not you know yeah well that time yeah that seems a little you know probably not realistic is Olo has to be a seller, but they have made two small acquisitions. They made one

recently. I forget. It wasn't very sizable, but I think they might do a lot of bolts on ones as well. We'll see if that can work to help with the strategy. If you see the apps that are in your partner ecosystem getting used a lot, maybe just keep buying those. Keep buying those. Well, if it's with stock, it's free, right? No. But Brad, what would you think if Olo got acquired at twice its market gap, which would be cheaper than what toast gross profit multiple is at, but would still be, you know, very expensive. Yeah. I, so I'm not, I would never be upset with a hundred percent profit profit day. Uh, I mean, I, I do have really lofty expectations for Olo, but I mean, I, I, who, who can be upset with that? But Ryan, I think the thing that makes

most sense is that Toast has not, at least to date, had a lot of success moving upstream to these larger clients and brands that Olo has been really great at servicing. Toast is handling the mom-and-pop restaurants, and Olo is handling the Subways, the Applebee's, and the Fridays, and the Carl's Juniors of the world. Just opening the door inorganically to those partnerships and relationships, I think Ryan's dead on that that would make a lot of sense for them. Yeah, that makes sense. I'll hit mine and it kind of goes into what maybe they would do through acquisitions, but I think the more subscription add-ons is going to be beneficial. If you look at their margins, this is almost as important as financial technology and it's

growing pretty quickly. You can kind of tell the software that's going to be inside a restaurant is probably going to be pretty sticky. They have that net revenue retention rate that has been above 110% for six years, like Ryan mentioned, I have a bit of a caveat because that is revenue. And I wonder how much of that has moved in gross profit. Maybe it's been even better because of the margin expansion, but I get concerned when a low margin business is having net revenue retention. But that number does lead me to believe that the restaurants they signed up in the past year, and I think they've doubled their restaurant count within, I think a little over a year, but I think it was two years, maybe they've doubled their restaurant count.

That gives me confidence that they will at least get, while maybe not as good as some of the top software companies like Brad was mentioning, they can still get solid revenue growth from these non-point-of-sale services or just expanding the point-of-sale services from the existing restaurants and getting them to add on more of these software solutions. That seems like the only real way. They've kind of cornered themselves in and saying they're only serving the restaurant industry and they already have all these products. So it seems like they just have to get it into the hands of the customers. All right. Highlights and lowlights. Brad, what did you like and dislike about this business? Yeah. So the highlight here is I really think the restaurant space is underappreciated. It is unloved. So before the pandemic, for the first time ever, restaurant spend surpassed grocery spend. Delivery and off-premise was the largest driver of that growth. And that's really exactly

where Toast is helping these companies proliferate. So I really do think they're in the right place at the right time. The COVID-19 pandemic put a huge dent in that restaurant spend, but it's expected to bounce back extremely quickly and resurpass grocery spend next year. So I really do like the restaurant space. I don't like restaurant operators just because that's an extremely difficult business. But these ancillary plays that are uplifting and supporting these restaurant chains and these restaurant brands, I really do think that that's a well-placed niche. But in terms of the low light, I don't like the reliance on hardware personally. I understand that they're doing it to get in the door and to upsell their software. But I mean, that's why the margins

stink. And not to use valuation in the highlights and low lights, but lower margins do not deserve premium valuations. And this company has that. So I guess I'm breaking the rule a little bit, but that's how I see the low light. Right. All right, Ryan. So highlights for me, I do think it's a pretty good business. I like the focus on the restaurants. And I'd also say that they've demonstrated an ability to add locations. Maybe there was some low-hanging fruit. Maybe there were a few restaurants that just simply had legacy systems that needed to switch. Well, think anecdotally. I believe, I mean, about half of the ones I go to still have a pretty bad one. Wouldn't you think?

Yeah. But I imagine getting to 48,000 locations this quick shows that they must have a product that restaurants are eager to have. And so obviously there is sort of a strong customer value proposition. My low light though, and you guys can correct me if you think this doesn't make any sense, but churn is pretty high in the restaurant business just because of failure rates. um and so there's going to be sort of sustainably high installations which means hardware revenue is going to be pretty high um yeah i think that's true and we should caveat though this is for more of the individual restaurants that toast is serving so large chains have less yeah so if it's like olos are mostly franchises these really aren't franchises if you're going to the local

restaurant they're unfortunately a lot of restaurants have high failure rates if if that closes, a new one opens, you go to try to sell it to them again. You've got to install the hardware. The hardware is a negative gross margin. So I'm worried that maybe that negative gross margin hardware sticking around is kind of going to keep the gross margin levels down somewhat. That is a good point. That's a very good point. I didn't think about that. All right. I'll hit mine. Highlights. I do think it's a good business model. They do have to sell, like Ryan said, the hardware up front. They have the professional services. That is a negative gross margin. And then, you know, um, the financial technology stuff is low margin, but pretty reliable,

but I do love the software aspect of the business. I like that they're focusing on restaurants because if they just try to copy square, I add in Clover, it's kind of hard to see how they would win kind of coming from the standing start. And I do think these type of products like Brad was mentioning are great businesses because of how sticky they are. high margins. Lowlights, though, I'm not sure they're better enough to really win customers from existing Square or Clover, people that use those products. I understand, though, if I was an SMB, I understand these products now because I've researched all these companies at this point. I would definitely use Toast if I was an SMB, but I don't think most small businesses,

Because they're not reading the S1s. I don't know. Yeah, they probably aren't. But I mean, think back to like 2017. If you go read a square shareholder letter or an annual report from 2017, and you just focused on the seller ecosystem, you could say, how much would you be willing to pay for this? And now we're going to get to whether we hit more or less interested, but I think it's

important. That's kind of a useful comp is to go back to that and say, how much would you pay for that business? Because you can see what the results have been. Now, maybe Toast is a little further ahead. Maybe the niche or the niche focus is better for them. But we'll see. Yeah, I would have.

I would have thought this being such a commoditized product would wouldn't have such good results because they've been able to grow. Yeah. Well, the thing about that, I think there's switching costs. It's hard to get someone to choose you over someone else. But once you're in, I feel like it's hard for a restaurant to switch. and that can be a benefit for someone that starts out early and is going against those really bad legacy solutions. But I'll say lastly, before we move on to the end of the show, last low light is I do not like their granting pace on options and RSUs. That was a huge turnoff

and it looks like, and I wasn't doing any actual math, but just kind of doing a little bit in my head from what I was reading on their granting pace and exercise pace, it seems like shared dilution could be higher than 5% per year, which feels very aggressive to me. And that will be a huge headwind. All right. Bull case, Brad, what do you think you go right for, excuse me, for the stock? Yeah. So I talked about this a little bit, but they highlighted this pursuit of larger clients and their filings and their roadshow and how they're pitching this business. Right now, just simple, quick arithmetic. It looks like locations per client is below two. So they haven't found a lot of success in realizing that objective, but finding success there, I think

could be a really, I mean, it's tough to break into large brands, but once you get there, it's a really easy way to seamlessly expand. I mean, just going back to Olo, they're servicing Jimmy John's and Wingstop. So every single time a Wingstop opens up a new location, Olo's growing, and you don't get that same kind of location growth with the SMBs who are pouring, families pouring all of their resources into opening a restaurant or something like that. So the bull case for me is that they find success in moving upstream and this under two locations per client moves precipitously higher, which not only will that be good for volume, but these larger clients are also inherently higher margin business for these

types of clients, which would be a very welcome tailwind for this company. All right, Ryan. I have a hard time getting comfortable with any bold case here. It's just, I mean, so Toast has 48,000 locations as customers today. So apparently that's about, I think they estimated it at 6% of the U.S. restaurant market. If they got to 50% market share, assuming this similar average gross profit per restaurant, they would be trading at a price to gross profit of 15 times. That's 50% market share.

That's like a 7X increase, more than a 7X increase in the customer base. And that's still not a super cheap multiple. And you're not pricing in share dilution. Yeah. So it's hard to really, that doesn't seem like you're going to get great returns. And it's assuming a very rosy future. Yeah. I'm going to go to mine.

I'm going to be frank. I don't think there's a bull case unless they come up with an entirely new business line. they have to come up with something else because it just doesn't it makes zero sense i'm gonna i'm very internet whoa whoa international expansion whoa we're coming all right don't worry it's coming uh but i think they have to make something else the cannabis thing makes a little less sense but that feels accretive it's got to be something entirely new brad what do you got yeah maybe just i mean if if they can in this incredibly rosy not super realistic scenario, eclipsed 50% market share of their entire opportunity. You could almost introduce

like a loyalty card or something to have people using the Toast brand and getting points and saving and whatever. But I agree they need more. And I'm just kind of brainstorming, spitballing what that could look like beyond cannabis, because obviously that's an amazing opportunity. i mean that no that that makes total sense and i think square realized that in 2015 and that was their vision for the cash app and now that's materializing so toast having to compete with the cash app who has the relationship with the existing square sellers feels difficult but i think that that does make sense uh all right bear case um i think this one it'll be easy for all of us. Brad, what do you got? Yeah. So Square sells their hardware at cost

just like Toast does, way deeper pockets. There's a dozen of competitors like this offering POS solutions. So the bear case is there's nothing all that special here. And then combining that with a hundred times gross profit, I don't know. But the bear case is lack of differentiation in extremely crowded space yeah no you kind of i think you put in more thought than me and ryan because you actually went to the business part of it and i like that square square could definitely undercut them and they'll be they're a lot larger so they can be fine ryan well what's your bear case uh multiple compression is basically the the biggest worry if you're an investor here um and if you don't if you're like oh you know you're just by quality sit tight yeah then

And let me ask you, do you think it's going to trade at a hundred times gross profit forever? I doubt it. And how long do you think it's going to take to get to a free cashflow yield of 10% at the current price? I'd say that's, it's two and a half billion in free cashflow right now. They're not including share deletion. I will say that a third time right now they're doing, I think 38 million. It's going to take at least 10 years.

More longer, longer. Yeah. But if you buy quality, if you have a super long time horizon, I mean, your returns will be subpar. You might as well index. Yeah. If you say, yeah, for anyone that says, well, it's a good business, I'll buy at any price, I will buy the shares at 107 times gross profit and sell them to you for 1,000 times gross profit. Yeah. If that makes sense to you.

What are the shares at today? If you were offered the shares, if you went and you're like, I'm going to buy toast at any price. and someone offered you the shares for four times the current price, that's the only shares you could buy. You weren't allowed to buy them at your current price. Would you buy them? Because that's buying them at any price. Yeah.

No, I mean, I agree. And the reason we say 10% free cash flow yield or 10% earnings yield is because in our view, when you're buying a stock, you're taking a stake to get the future cash from a business and you're paying something for that. And if you're getting that 10% free cash flow yield, That means, at least on your cost basis, and that's what we're referring to, a 10% free cash flow yield on your cost base, that is a guaranteed 10% return per year if they can

sustain that on your cost basis, and they can technically pay that out to shareholders. But no need to ramble on that. I'll hit my bear case. Let me do another scenario for you. If net revenue retention stays strong, and eventually they can do $500 million in gross profit from their current locations, which would be about double their $20,000 in 12 months. I think over a decade, that could be reasonable, but still a bit aggressive. And if they capture the entire U.S. market, I estimated that they would be doing around $9 billion a year in gross

profit. That is maybe what makes sense on their current market cap, if you include share dilution. If they were doing $9 billion in gross profit, probably it could be worth more. we'll see what they're more serious. I I'm, I'm including the shared illusion over that time period. I think especially with the churn on this stuff, I think there's high costs coming in. I don't know. We don't need to ramble more or less interested, Brad. What are your closing thoughts on toast?

Yeah. Less interested for me. Nothing super special about this business. In my opinion, it seems like they do a lot of things pretty well, but they, uh they are priced like they do everything extraordinarily well and i i don't know i don't i don't see them differentiating themselves all that much from from square or from clover from these other pos systems and it just really feels like it's it's going to be a race to zero in terms of who can sell um who can sell this hardware yeah who can sell this hardware more cheaply to to add on these software functions and in that scenario i mean square wins they have more

money they have more resources they have more time they have more brand awareness so they win and that's kind of how i sort of see this playing out we're saying bull case they have to get a ridiculous amount of market share and i think square is going to get a ridiculous amount of market share so yeah i mean i will i am very confident there's no way they're stealing any sort of significant market share from square clover from their existing clients Yeah. Ryan, what are your closing thoughts? Well, I'm less interested. I think that's clear. I think what we should be talking about is the fact that the IPO process is completely broken. No one thinks this is a good price. I haven't

seen anyone that had positive comments on Toast as an investment. This needs to be fixed. And it's happened with IPOs over and over and over. When the lockup expires and all those shares get get unlocked and they start getting sold, they're getting sold off 80%. If this sold off 80%, I still might not be interested. Oh, it'd be still very expensive. Brad, you have something to add? Yeah. So for our viewers who are in love with Toast Business Modeling, who feel really passionate about owning the company, first of all, I don't think you're crazy. There are a lot of things to like about this company, but just with organizations that come out of the gate flying like this does, for me, the personal examples are Lemonade and Olo

and Duolingo. I don't want to give advice, but for me personally, it makes a lot of sense to start as small as you possibly can with your initial purchase by 10% of a starting position, by 15% of a starting position, because we know that turbulence is likely coming and that just gives you so much more flexibility and so much more opportunity to add to these great companies at more realistic multiples and to bolster your returns over the very long term. So just be careful inching into names like this. I don't think it's crazy to want to own toast. I do think it's crazy to invest a hundred percent of a full position in toast today. Or even start with zero percent right now. That seems like a good position. Yeah. I feel like this is even getting

crazier than like a starter position, but I do in general, I like that philosophy of, if you like it, I mean, the Molly fool is the classic buy in third strategy, which I think makes sense most of the time. All those things out with mine, I am less interested. I think the business looks solid, but is so grossly overvalued, like both of you guys were saying. Just think about the dynamics with the lockup period. 88% is locked up. That will get unlocked within 180 days. Once that happens, we're not oracles here, but I mean, you know what's going to happen.

I am very confident that, I mean, just think about what, you know, like there's people that are going to have to sell. there's such a tiny float out there right now the supply is going to expand and the price just it's going to drop i i don't know what else there is to say who's buying this no one is because it's 88 is locked up that's the whole point i would not i'm kidding i'm totally kidding rent tech i don't know just it's just it's just short-term traders maybe who knows uh either way i think this is a fun episode uh and we're gonna do stock for next week and it's my turn i think right because you chose braddy chose toast okay yeah yeah we're gonna do a fun one that everyone knows snap otherwise knows the company that owns snapchat i don't think we've covered that either in a very

very long time the business has evolved a lot it is done the stock has done extremely well so i like to investigate that see why we well brad i don't know if you own it but i'm a user so you're a user ryan uh brad i am a social media mark zuckerberg loyalist so no i do not own on Snapchat. All right. Well, we're going to all see why we missed out on this 10-bagger in front of our eyes, not to hate on our investments, but yeah, that'll be in two weeks. So let's get to the disclosure here. Remember, we are not financial advisors. Anything we say on this show is not formal advice or recommendation. Ryan and I are general partners at Arch Capital. Arch Capital clients may hold securities discussed in this podcast. Thank you all for listening. We'll see

you next time. Thanks for watching!