Par Technology (PAR) – “Uncovering the Crown Jewels”

Company:         PAR Technology (PAR)
Sector:                Technology – Application Software
Price/Market Cap:                        $26.30/$458M
Target Price/Implied Upside:     $41/55%

Thesis

PAR Technology Corp. (PAR) is an underappreciated, cloud-based, Point-of-Sale (POS) software provider anchored by its legacy as a government contractor.  New leadership has redirected the company to be laser focused on their future in the cloud.  The Balance Sheet has been recapitalized with a $80M convertible debt raise.  Proceeds will be used to accelerate the growth of their cloud based recurring revenue, and solidify their market position through bolt-on acquisitions. Growth of SaaS recurring revenue will improve margin and profitability profile and force a multiple revaluation. The Government business will continue to be a source of cashflow until the company finds an attractive buyer leaving the company as a pure-play, cloud-based restaurant and hospitality solution. Longer-term, the real growth opportunity may be in their nascent merchant services business launching in 2H 2019.

Catalysts

• Transition to pureplay, cloud-based, software services provider focused on QSR and hospitality
• Closed $80M in convertible debt to accelerate transformation. The raise came with much needed analyst coverage from a major investment bank (Jefferies).
• Launch of merchant services capabilities in 2H 2019; revenue stream could eventually surpass SaaS cloud revenue.
• Largest shareholders are activists pushing management team in the right direction.

History
PAR Technology (PAR) was founded in 1968 as a government IT contractor focused on the Department of Defense. The company later expanded into developing hardware-based, point-of-sale (POS) systems for the Quick Service Restaurant (QSR) market. The company was able to secure significant Tier-1 customer relationships including McDonald’s, YUM and Arby’s. The company’s hardware-based systems are considered to be the Cadillac of the industry: solid, reliable, and able to withstand the harsh operating environment of a typical restaurant kitchen.  However, hardware margins are thin and revenues were subject to the cyclicality and health of the restaurant industry, as well as the purchase cycle of its largest customers.  To reduce cyclicality, PAR acquired Brink Software in 2014.  The Brink acquisition brought the company both a cloud-based POS software solution and an opportunity for high margin, recurring revenue. As this recurring revenue grew, investors began to take notice.  In 2018, activist investors pushed the company to its next phase with a change in leadership. Legacy management (including the founder) stepped away.  PAR raised $80m in convertible debt to support transformation efforts.  Our call with management revealed that the new management team and positive activity have renewed the energy within the company.

As of December 31, 2018, PAR employed approximately 1,000 full-time employees, including approximately 51% in its Restaurant/Retail segment, 44% in its Government segment, and 5% who are corporate employees.

Market and Company

PAR is a leading provider of POS solutions to QSR and hospitality and operates three primary businesses: Brink POS Software, POS Hardware, and Government IT Services. As of 2018, approximately 67% of revenue comes from restaurant and retail with the remainder coming from unrelated government IT services.

According to Statista, there are more than 660k QSR restaurants in the U.S.  Par focuses on Tiers 1 and 2 (Tier 3 opportunistically) of this market which includes restaurant chains with 100+ sites.  The Total Addressable Market for these tiers is some 182k restaurants.  Sales within Tiers 1 and 2 are driven primarily by replacing incumbents which creates a challenge. Replacing technology systems within a restaurant can be disruptive to the business as it impacts labor scheduling, logistics, and often requires employee retraining.  Restaurants are wary of upgrading systems unless outside forces push them to it. The QSR market is currently undergoing significant change that demands that restaurants address loyalty, mobile ordering, and delivery. These changes are driving technology adoption and an industry-wide technology replacement cycle, creating an opportunity to replace incumbents.  Once new technology is installed, the business is very sticky with an average refresh cycle of 5-7 years.

Cloud based solutions directly address the industry evolution by allowing restaurants to add modules or make significant software updates seamlessly in the background without requiring major hardware changes.  The Brink solution leverages Amazon AWS for hosting, eliminating the need for an on premise back-office server and reducing the risk of credit card hacking.  Menu changes and labor scheduling adjustments can be made fairly simply.

The industry wide conversion from on premise solutions to the cloud is in its early stages. 

Products
Brink POS Cloud Point of Sale – Brink is a cloud-based, SaaS POS platform that eliminates the requirement for an on-premise, back-office server and simplifies software version control and organizational updates. Brink is designed for multi-unit restaurants and integrates into mobile/online ordering, loyalty, kitchen video systems, guest surveys, enterprise reporting, and mobile dashboards. With over 8,000 installs including Arby’s, Dairy Queen, Five Guys, Sweetgreen, and Smoothie King, the segment represents a smaller portion of overall revenue but the segment is growing 80% year-over-year with very low churn.

POS Hardware for Blue Chip QSR– PAR’s hardware POS platforms are designed to reliably operate in harsh environments associated with food service. The platforms are durable and highly functioning, scalable, and easily integrated – offering customers competitive performance and price. PAR’s hardware platforms are compatible with popular third-party Microsoft based, operating systems. PAR’s open architecture POS platforms are optimized to host PAR’s proprietary POS software applications, as well as many third-party POS applications, and are compatible with a variety of peripheral devices. PAR has long been considered the best in class for hardware. PAR partners with numerous vendors that offer complementary in-store peripherals, such as cash drawers, card readers, and printers, allowing for delivery of a completely integrated solution through one vendor.

PAR Government –PAR provides mission critical geospatial intelligence and SATCOM capabilities for the DoD and Intelligence Community. This includes a variety of geospatial intelligence and situational awareness solutions for mobile and data center offerings.  They also provide continuous 24/7/365 Satellite and Teleport facility operations and maintenance, engineering and installation.

The remaining PAR revenues consist of various support services sold to QSR and independent table service restaurants sold through their channel partners.  These services include on-premise integrated software solutions such as self-service ordering functions, back-office management, and an enterprise level loyalty and gift card information sharing application. PAR also offers installation, technical and break-fix support for products through license and/or subscription agreements with our customer.

The new management team is intensely focused on building the Brink software business while de-emphasizing POS hardware.  The focus for our investment is the Brink business which we view as the true “crown jewel” and the source of future value.  PAR is likely to divest the Government business at some point in the future leaving the remaining company to be a QSR software focused pure-play.  In the interim, the Government business continues to generate significant cashflow to support reinvestment in other segments.

Emerging Product Opportunities
With the renewed emphasis on their Brink solution, PAR has already identified an emerging revenue opportunity and that is merchant services through their “PAR Pay” module. PAR Pay is a payment module where the company charges a recurring fee for processing payments.  The module supports Apple Pay, Google Pay, Samsung Pay, and PayPal with Near Field Communication (NFC), and will enable PAR to increase ARPU by capturing a percentage of all credit card transactions with a ~40bps take rate for each transaction. If we assume that each Brink enabled store generates $1.75M in annual revenue, a 40bps take rate translates to an additional $7,000 in revenue per store for PAR.  Compare this to the average of $2,040 annually per store for their existing Brink platform and services.

While many POS system competitors make the majority of their revenue from their payments business, PAR currently has no revenue from payments.  Par Pay is expected to launch in the second half of 2019.  Over time, we believe payments could become the largest revenue generator for their business. 

International expansion is another untapped opportunity.

Customers
The strength of PAR’s products is reflected in the customer relationships they have developed.

PAR hardware Customers include KFC, Subway, McDonald’s, Pizza Hut, and Taco Bell. These large franchises already trust and rely on PAR solutions.  Yet, none of these customers currently use Brink, which we view as an attractive opportunity.  Of the 8,000 restaurants currently booked for Brink, noneare existing Tier 1 hardware customers.  Another huge opportunity. PAR has hinted that at least one of their existing Tier 1 hardware customers will be transitioned in 2019.  The year is back half loaded.

PAR does have customer concentration. However, this is diminishing over time.

Competition
The Point-of-Sale market for software and hardware offerings sold to restaurant and retail is highly competitive and rapidly evolving. Most larger customers have several approved suppliers of software and/or hardware.  Par Technology’s most direct competitors include Micros and NetSuite (both subdivisions of Oracle) and NCR with their Aloha product.  Beyond the big three, there are dozens of smaller applications with limited product capabilities competing for Tier 3 and Tier 4 customers and other opportunities with fewer than 50 stores. These smaller competitors are frequently unable to scale to meet the needs of enterprise. PAR competes based on product capabilities and design, features and functionality, software applications and integration capabilities, quality and reliability, price, and customer service.  We expect competition in the QSR POS market to continue to increase, including competition from both cloud-based and traditional on-premise POS software and hardware providers, payment processing companies expanding into the POS market, and other business software and solution providers. PAR believes that its competitive advantages include its integrated solutions offerings, including its cloud (SaaS delivery model) and on-premise software, ergonomic purpose-built hardware, advanced development capabilities, extensive domain knowledge and expertise, excellent product reliability, a customer dedicated direct sales force organization, and responsive customer service and support.

Management
For much of its life, PAR was family run with both the founder John W. Sammon, Jr. and his daughter each serving stints as CEO.  With the acquisition of Brink, investors began to take notice. Savneet Singh approached the company about buying the Brink business from PAR.  The Board rebuffed him as the company was uninterested in selling.  Instead, based on the suggestion of a major shareholder, Mr. Singh was added to the board because of his experience building software companies.   His impact was immediate and, within a year, he was appointed as “interim” and later permanent President and CEO. He was influential in the capital raise as well as right-sizing the corporate cost structure so that more resources could be devoted to growing Brink.

Mr. Singh was previously an investor in software businesses having co-founded Tera Holdings, a holding company for niche software businesses.  He is also a partner and director of CoVenture, LLC, a venture capital firm.  He has experience running small software companies having founded Gold Bullion International, LLC and serving as its President, COO, and CEO from 2009 to 2017.

During his brief tenure with PAR, the company has completed an $80m convertible debt offering while reducing 8% of corporate staff to free up capital and additional reductions within their hardware unit. Our call with management revealed a new energy at the company where employees are happy to come to work.  Mr. Singh is working quickly to change the corporate culture by reducing bureaucracy and connecting performance to compensation with every employee having a personal KPI to measure their progress. He has tasked Investor Relations with getting the word out.  Mr. Singh has also shown an interest in focusing the company on capital allocation:

“I am committed to disciplined capital allocation and carefully monitoring the return on that invested capital to ensure that PAR is investing in the correct initiatives to increase value in our company. While we have immense respect for the heritage and legacy of our past, we understand that we must change and provide a level of transparency to our employees, customers, and shareholders.”

–Savneet Singh Q4 2018 Earnings Call

Financial Performance and Valuation
Our valuation estimates for PAR will continue to evolve as we learn more about the company and understand market acceptance and growth rates for their newest products.  We considered a DCF valuation, but found ourselves making too many assumptions related to Brink market acceptance and the roll-out of merchant services. Instead, we valued the company using a SOTP using conservative, near term estimated 2019 numbers.  This result gave us assurance of a 50%+ margin of safety with significant growth ahead.

(Cash and debt figures reflected pre-convertible debt raise)

For our Comparable revenue multiples, we considered the following companies:

• Government: Booz Allen Hamilton, SAIC
• Hardware: NCR, Diebold Nixdorf, ScanSource
• SaaS: Salesforce, Workday, Oracle, Microsoft, Adobe, Shopify, ServiceNow

Even if you believe the current market multiples to be stretched, a 20% discount to current market multiples points to a 28% margin of safety.

Looking ahead, we believe that conservative growth in the Brink business combined with reasonable penetration of their merchant services capability leads to an achievable growth path to a $2-3B valuation.  While the SaaS component of Brink is compelling by itself, we believe an even larger opportunity lays in payments.

Risks

• Change is challenging. Management will have its hands full making the necessary changes to the business without alienating key employees. It’s a balancing act.
• Headwinds converting existing Tier 1 customers to Brink.Major technology implementations will always trigger a broad RFP leading to a possible loss of hardware revenue instead of an increase in software recurring revenue.
• Smaller competitors (Toast, and others) are raising cash at stratospheric valuations. Competitors may be able to outspend Par to relevancy.