October by D’Ornano + Co. - Why a new holistic framework is needed to understand Tech valuations, why Toast is succeeding, and how to make cash flows more relevant?
This is issue number 2 of our monthly newsletter dedicated to Tech x Investments.
Valuing high-growth companies is both a challenge and an imperative in today’s deal-making environment, where nontraditional investors - a majority of them being PE funds - expand into the late-stage/growth segments which were solely occupied by VCs until not so long ago.
Using EBITDA as a sole metric to assess a Tech company’s valuation is a shorthand method. We substitute it with a holistic approach which provides a full picture of what drives a company’s valuation, as we’ve explained in this “Les Echos” article (..). Our approach combines a deep understanding of the key financial and operational KPIs of a Tech company (of which “ARR”), as well as of the regulatory and IP/data hurdles per each Tech vertical.
In our S1-teardown of Toast, a US-based Restaurant Tech company, we highlight the complexity of defining ARR in a dominant, usage-based pricing model.
But rest assured: once the fundamentals of a business model are clear, the gap created by today’s accounting between financial statements and what an investor needs to understand in a high-growth business can be easily resolved, as Morgan Stanley outlines in its “Categorizing for clarity” analysis.
Why is EBITDA dead?
Tech businesses need a holistic approach with new metrics in order to understand their value. Discover why this new approach is a must for investors, with Jérôme Hervé and Raphaëlle d'Ornano in Les Echos.
This month's spotlight is on Toast Inc.
Toast Inc. (the “Company”) is a cloud-based, end-to-end technology platform purpose-built for the entire restaurant community. Its platform provides a suite of SaaS products, financial technology solutions including integrated payment processing, restaurant-grade hardware, and a broad ecosystem of third-party partners. It serves as the restaurant operating system, connecting front of house and back of house operations across dine-in, takeout, and delivery channels. Founded in 2010, the company raised c.$870m in its initial public offering on the New York Stock Exchange on September 22, 2021;
The Company is disrupting the legacy market of the restaurant industry with a solution addressing the needs of “mom-and-pop” restaurants as well as larger regional, national and global restaurant chains. As of June 30, 2021, approximately 48k restaurant locations across 29k customers, processing over $38 billion of gross payment volume (“GPV”) in the trailing 12 months, partnered with the Company to optimize operations, increase sales, engage guests, and maintain the happiness of employees. As a reminder, GPV represents the sum of total dollars processed through a payment platform across all restaurant locations in a given period;
The Company took a severe hit with COVID-19, but showed both support to the whole restaurant community, and resilience as sales reached $704m over S1 2021 (vs. $344m in S1 2020). ARR reached $494m on June 30, 2021;
Except for marginal hardware and professional services sales (<9% of total FY20 revenue in total), the Company derives its revenue from its software. Software revenue includes a subscription part (c.12% of FY20 revenue), but the majority stems from the revenue derived from the payments operated through the platform (c.79% of FY20 revenue), captured through GPV, and considered as “usage MRR”. The Company has defined its ARR in what we view as interesting as it is not simply MRR*12. No, it starts by splitting its MRR into two components, the subscription part (easy) and the usage-based part derived from payments. It then states that its ARR is its subscription part MRR*12 and 4 times its trailing last 3 months payment MRR. There could be a discussion on that 3-month reference period however, and it will be interesting to watch new definitions that will arise in the coming months for software companies building more financial capabilities into their original applications;
In line with its revenue sources, mostly made up of commissions on the payments processed through the platform, the Company does not have the margin levels of your “traditional” SaaS company, with a gross margin of 17% in FY20! The Company’s scalability will derive from how it finds improved margin levels on the payment activity (the subscription margin is roughly in line with software standards, at c.65% of net sales, though there is room for improvement);
From a legal standpoint, the Company has strong intangible assets deriving from its IP portfolio, and notably from its patents which protect its technology;
Lastly, in light of its international expansion, the Company could face a challenge related to its data collection: Guest data is collected in mass (5.5 million orders a day), and the Company will have to anticipate the business consequences that could result from compliance with EU data protection regulations.
Morgan Stanley highlights in this report how today’s accounting creates a huge gap between financial statements and what an investor needs to understand in a business. This is despite the conceptual match between categories on the statement of cash flows and how businesses work. They show us how moving certain items from one category to another improves relevance without affecting the essential task of cash reconciliation.
Coinbase, the largest cryptocurrency platform in the United States, listed its shares on the stock market in April. The warning to the company is an indication that the S.E.C. is closely watching cryptocurrency companies, especially as they move into regulated territories (i.e. banking). Other companies have faced such threats such as BlockFi recently, and it will be interesting to watch the frontiers between incumbents and emerging players in this booming area of finance.
Legalstart
D'Ornano + Co. is delighted to have accompanied Legalstart.fr, the European leader in LegalTech, in its LBO transaction alongside its historical investor ISAI and its new partner Omnes!
NGE
D'Ornano + Co. advised Montefiore Investment on its legal due diligence for its 28% long-term equity investment in French construction key player NGE - BTP. Our team, led by Raphaëlle d'Ornano and Thomas Priolet, was delighted to work again alongside Montefiore on another structuring deal!
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