Employee uses point of sale app on tablet
Introduction
This has been a good year for stocks, aided by continued government deficit spending and a Federal Reserve talking of cutting rates some time soon. A rising tide lifts all boats, even the slowly leaking ones. We even had a mini meme stock rally!
For as long as the eye can see, Par Technology (NYSE:PAR) has generated operating losses. Yet, this has not stopped its investors from spinning a tale of riches just around the corner.
Company background
Par has two strangely different business segments. The first (and the important one, accounting for two-thirds of revenue) is the Restaurant/Retail segment, which provides hardware and software solutions to mainly the restaurant industry. These encompass point of sale terminals, payment services, and loyalty solutions. The largest customer here is Yum! Brands. The company got a win at Burger King last year, which it is in the process of implementing. The second is the Government segment, which provides services to the US Department of Defense and federal agencies. There is no obvious synergy between these two businesses!
95% of the company’s revenue is generated in the US. The company was founded in 1968 and is headquartered in New Hartford, in upstate NY.
Par quarterly financial overview
For the quarter ending March 31, 2024, Par reported $105.5 million in revenue, up 5% YoY. This included a decline in hardware revenues, without which the increase was 18%. The company touted organic Annual Recurring Revenue (ARR) growth of 25%. Operating income was a loss of $25 million. This included $4 million in transaction costs and $5 million of intangible amortization. Excluding these, I calculate an adjusted operating loss of $15 million (-14% operating margin), representing a $5 million deterioration from the prior quarter. The average share count for the quarter was at 29.5 million, was up 8% YoY, but did not reflect the full extent of the shares the company issued during the quarter. The ending share count was 34 million.
The company has a market capitalization of $1.7 billion at the current share price of $50. It has $300 million of net debt for an enterprise value of $2 billion. This amounts to 4.2x expected revenue for this year.
The biggest item on the balance sheet is $600 million of goodwill, an indication of how the company has grown through acquisitions. Deferred revenue was $18 million, or a mere half a month’s sales.
The cash flow statement showed nothing amiss, with free cash flow being an outflow consistent with the company’s operating loss. The company used proceeds from a $200 million stock issuance to pay for an acquisition.
PAR stock valuation and recommendation
Valuing a company that has a negative operating margin, involves assuming that it will become profitable in the future. To value Par Technology, I will assume that it can scale up its business model and reach a GAAP operating margin of 6%, representing a 20% improvement from the most recent quarter. I consider stock-based compensation to be a real expense, and do not ignore it, although I give the company the benefit of doubt for the intangible amortization.
A 6% margin on 2024 anticipated revenue of $470 million would result in normalized annual operating profit of $28 million. Due to Par’s large net operating loss carry-forward (accumulated deficit of $293 million), it is safe to say that it will not pay taxes for a decade at least. So I will apply a 0% tax rate for $28 million in after-tax operating income or $0.82 per share. I will apply a generous 35x multiple to arrive at a per share value of $29 for the business. Most new-age software companies are unprofitable or marginally profitable, so there are no good comps. An established and profitable software company like Microsoft (MSFT) trades at 36x earnings. To value the equity, I will deduct net debt, amounting to $9 per share on the balance sheet to arrive at a fair value for the shares of $20. This would represent a 60% downside from the current share price of $50.
In a bull case, the company would get to a 10% operating margin, resulting in normalized annual operating profit of $47 million or $1.38 per share. At this level of profitability, the NOLs won’t last too long, but I will be generous and assume zero taxes. I will apply a higher 50x multiple to arrive at a value per share of $69 for the business. Deducting $9 per share of net debt would result in fair value for the shares of $60, resulting in 20% upside from the current share price. So there are gains to be had, if the company can dramatically increase its margins and garner a high multiple.
Since there is so much downside even in the base case, I will skip presenting a bear case, except to say that a continued lack of profitability and debt on the balance sheet points to the risk of a large drawdown.
I recommend that investors use the current rise in equity prices to sell any position they may have in PAR stock. For those looking to hedge a long portfolio, I recommend shorting the stock. The short interest is moderate at 17% of float and 14% of shares outstanding. The shares are easy to borrow at a minimal fee, so one can obtain close to 5% at current interest rates on the sale proceeds as a short rebate.
Loyal investor base
The shareholder base of the company is a veritable hedge fund hotel, apart from the standard large institutional holders, and they were gracious enough to subscribe to $200 million of shares earlier this year, so that the company could make an acquisition. I can see the qualitative attractiveness of the company. Growing ARR, a large market opportunity, a dynamic CEO, potential contract wins in the future. Everything is good if you ignore the losses, but this can be rationalized away as about to inflect in the future.
Variant view
I believe the opportunity here exists, because investors are focusing on non-fundamental metrics like EBITDA and ARR growth, while ignoring the unprofitable nature of the business. I don’t like to make killer thesis points in an investment recommendation, since I prefer to analyze financials, but if I were the dramatic kind, I would say that AI could have a material adverse effect on the company’s business. Voice recognition, for instance, could allow restaurants to lower their costs and obviate the need to invest in the kind of POS systems the company sells. As a small company with limited means, it will be difficult for them to invest in developing AI capabilities (good luck getting Nvidia chips!)
Risks are moderate
The main risk I see for any small or mid-cap company is acquisition risk. At a $2 billion enterprise value, this is well within the range of deals for a private equity firm or a corporate acquirer. I’m sure enterprising investment bankers could persuade buyers to ignore the operating losses and focus on the metrics that don’t matter! I can see a buyer imagining that there may be value in splitting the company, selling off one part, and keeping the other.
On a fundamental basis, the company could rapidly increase its revenue for many years, cut costs, increase margins, and become more profitable than I have projected.
Investors may continue to chase momentum, and an AI narrative associated with the company may develop.
Conclusion
With continuing losses, a large debt load and frequent acquisitions, Par Technologies is far from creating value for its shareholders. The company faces an uphill battle to become profitable. A less optimistic equity environment could cause a big drop in the stock, if investors start focusing on profitability rather than other metrics.
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