Toast Valuation

[Toast: Valuation](https://riskpremiumresearch.substack.com/p/toast-valuation) # Overview Toast provides Point of Sale services for restaurants. They historically have targeted small-to-medium businesses, but have been branching into larger franchises as of late (recent partnerships have been with TopGolf, Applebees, Huddle House). # Valuation Drivers Toast categorizes their revenue components into three categories - Financial Technology Services, Subscriptions, and Hardware & Professional Services. **Subscription Services** start with the basic monthly rate that Toast charges for using their system - this fee is generally less than $100 per month (per location). In addition, there are add-on features like takeout, marketing & loyalty rewards programs, inventory management, hardware subscriptions (i.e., handhelds) and other “back of house” functions like payroll management applications. **Financial Technology Solutions (FTS)** are split into two sub-categories. The first is payment processing. Every time someone makes a purchase and swipes their credit card, Toast collects a fee. A portion of this fee is divvied to the credit card company for transaction costs, while Toast keeps a slice for themselves. In addition, FTS also includes Toast Capital. Toast Capital is a program that lends money to restaurants. To-date, revenue generated by Toast Capital is a relatively small proportion of the total FTS pie. **Hardware & Professional Services (HPS)** is primarily driven by the equipment and support needed to setup a new restaurant on the Toast network. This is generally considered a one-time transaction. Currently, most of their growth comes from user growth. They're currently pacing at 20% location growth for the past few years, adding between 20k and 30k locations per year. I think they're kind of constrained in the number of locations they can add because it takes a good bit of upfront effort (Hardware & Professional Services) to bring on new customers. So I wouldn't expect a 100k jump in locations in any given year...even if there were demand for it. # Valuation I break down the unit economics in the [Article](https://riskpremiumresearch.substack.com/p/toast-valuation), but the gist is that once a store is set up on the Toast network, Toast commands about $10,000 per year per location in gross profit. Subscription gross margins are about 70%. FTS gross margins are in the low 20% range (this is mostly due to how they define revenue, though - I explain this in more detail in the article). Hardware & Professional Services operates at a loss where Toast shares the setup costs with the restaurant owner. By assuming modest growth, climbing to roughly 280k locations by the early 2030s, ***I get a fair value of about $30 per share***, which is right around today's market price. I think this still could offer a compelling value opportunity because investors are given optionality in the other markets that Toast is trying to expand into (while my valuation primarily focuses on their core business). Toast has a vision of expanding to 500k total locations in the long run. This requires expansion into international markets as well as other verticals (like Grocery). Based on my valuation, investors will get this 'potential' for free when buying at today's prices. # Risks The obvious risk is that the restaurant industry is probably the most fragile part of the economy - budgets for eating out probably are first to get cut in a recession. In addition, Toast Capital - where Toast underwrites & services loans to restaurants - has an interesting Tranche structure with their partnered banks where Toast has to take on the first 15% of defaults before the bank takes any losses. Toast's at-risk exposure in this segment is about $150 million so it's not a big deal yet, but something to keep an eye on. Most importantly, a bet on Toast is a bet on the U.S. economy. Speaking of "tranches", Toast's entire business model acts as a subordinate tranche. In an economic downturn, restaurants (and Toast along with them) probably take on losses first. Toast Capital leverages that even further. That's not to say that Toast isn't a good or bad bet, but it is something to be aware of.