Why I am transmitting the Toast IPO

Good companies don’t always translate into good investment opportunities. Unfortunately, this disconnect often appears when exciting new ventures like the restaurant point of sale platform Toast (NYSE: TOST) Go in public.

There are reasons to be excited about Toast as a company, but here’s why I’m passing on the company’s recent IPO – at least for now.

Toast’s place in the point of sale area

Running a restaurant is no easy task; there are many aspects to ensuring the smooth operation of the operation. Restaurants are often small businesses and their founders may know more about food than business management and logistics.

Image source: Getty Images.

Toast is a cloud-based point-of-sale and software service that helps manage all aspects of running a restaurant business, including order entry, menu management, analysis, ordering online and much more.

The point of sale industry has many competitors, including Square, Speed ​​of light, Toast, Stripe and others. These businesses have all prospered because the addressable market is so large: There are over 31 million small businesses in the United States alone, and that number includes approximately 860,000 restaurants. Toast was designed for the restaurant industry from the ground up. This specialization has enabled it to carve out a market share among the competition since the Toast platform serves more than 40,000 restaurants.

Looking at the numbers

Toast generates income in several ways and divides its revenue into:

  • Subscription services
  • Financial technology solutions
  • Equipment
  • Professional services

The company generated revenue of $ 703.7 million in the first six months of 2021, up 105% year on year. Such growth is impressive, but it’s important to note that the first half of 2020 included the start of pandemic closures when many restaurants temporarily closed their doors or reduced their service, which made the comparison “easier” by 2021. While investors should monitor how the business continues to grow with the pandemic under control, revenue for the first half of this year was still up 155% from the same period in 2019.

Toast margins are a more pressing issue, in my opinion. The company’s gross profit margin for the first half of 2021 was 22%, which is a bit low for a tech company. The culprit here is Toast’s sale of computer hardware and professional services, which cost more than they generate income.

Investors should look for subscription revenue growth as Toast expands its customer base over time. Subscriptions are the most profitable segment of Toast’s business with a gross margin of 66%, but they have only contributed 10% of revenue for the year to date. Otherwise, the business is not profitable if you factor in the expenses of sales and marketing, research and development, and administration.

The hype machine at full power

As companies prepare to enter public markets, investment banks that underwrite the Initial Public Offering (IPO) are evaluating the stock. A company’s financial data, peer comparisons, overall history, and demand for stocks can all impact the price at which a company goes public. As a result, “hype” can be a factor.

Toast received a lot of attention ahead of its IPO, and the initial offering price rose accordingly. The deal ended up exceeding its initial range of $ 30 to $ 33 per share, priced at $ 40. When Toast began trading on September 22, its price climbed further with an opening trade of $ 65.26 per share, although it has since moved into the mid-range of $ 50.

Why am I sending Toast

Toast has generated $ 1.18 billion in revenue over the past four quarters. Its market cap of $ 28.4 billion at the time of this writing values ​​the stock at a price-to-sell (P / S) ratio of 24. Although it markets itself as a SaaS (software as a) company. service), the low margin somewhat tarnishes this narrative and could make it difficult to justify the high share price.

Lightspeed, a similar company that focuses on the wider hospitality industry, trades at a P / S ratio of 35, but its gross profit margin is much higher at 54%. Meanwhile, analysts expect industry leader Square to experience similar growth to Toast this year (101% revenue growth for 2021), but Square has a similar gross margin (23%) but is trading at a P / S ratio of less than eight.

These comparisons aren’t perfect – small businesses can often get a higher valuation because they have more room to grow over time. But given the valuation of similar stocks, it looks like the investor hype drove a lot of Toast’s near-term upside, which is why I’m passing the action on for now.

This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.

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