PAR Technology - Riding restaurant technology trends

PAR has all the qualities to become THE POS player in the enterprise restaurant segment. We find out the importance of POS and how PAR can have a prominent role in upcoming restaurant tech.

PAR Technology (ticker: PAR)

What makes PAR interesting?

We bumped into PAR on Twitter and we have been intrigued ever since. PAR has been a trending topic on Fintwit. The sentiment around PAR is very polarized with parties for and against heavily making their argument. We rejected the thesis when we first looked into it. We thought that the company was in a too competitive market and without real differentiation from its peers. However, we kept on reading about PAR on Twitter and we listened to several podcasts with PAR’s CEO Savneet Singh as speaker. We were impressed by his intelligence and his very articulate reasoning about how PAR’s market is going to evolve. So, we dove further into the company and we were enthusiastic about what we found out. Singh has an investing background and lays out the investment thesis of PAR in his presentations and podcasts. After reading expert calls from Tegus and doing more due diligence we felt more comfortable with the investment thesis layed out by Singh. PAR is active in the US restaurant POS system market and this market is rapidly evolving from hardware to software business. PAR is really stepping up its cloud business and is continuously adding new products to its ecosystem that are of added value for restaurants. Our first thought, and that of some other investors, was that PAR is not differentiated from other restaurant POS system providers. However, the restaurant market is huge and PAR is in a specific segment of the restaurant market for which it has the qualities to become the number one.

Restaurant systems

A restaurant has to align multiple input sources in order to drive efficient operations and to give the customer the best possible service. Customers need to be drawn to a restaurant with promotions. When a customer orders food, the order needs to be placed (in-store, via a drive-thru, through a food delivery app, etc.), paid and sent to the kitchen. Work schedules of employees need to be planned. The shelf life of restaurants’ inventory is short so inventory management is critical. These operations were originally performed manually, but new technologies such as Point of Sales (POS) systems have made restaurant operations more efficient and effective.

Tech expenses

Besides, labor costs are around 30% in the restaurant industry, its highest operating expense. New technology can lower the labor costs of restaurants. Think of self-service kiosks in restaurants and voice-assistant technology for online ordering through Alexa or Siri. Tech spending is still low with most restaurants; spending less than 5% of revenue. So, there is room for restaurants to invest in tech.

Restaurants can use their tech spending in cloud-based systems to connect the POS systems and other technologies. Originally, they are connected with a server on-premise. However, on-premise servers require a big upfront expense in hardware and maintenance costs. Restaurant operational systems can be easily connected to the cloud to lower upfront costs. Due to the connectivity and scalability features, restaurants are able to connect a vast amount of operational systems to the cloud, giving restaurants the possibility to track and analyze data. Imagine the possibilities restaurants have with data of the behavior of their customers and the restaurants' operations. 

Business overview

PAR is riding the wave of new technologies in the restaurant industry. PAR delivers software and hardware to the hospitality business and Government. It delivers cloud-based POS systems for quick and service fast-casual restaurants (QSR), hardware for legacy QSR, and Mission Critical Geospatial-Intelligence And SATCOM Capabilities for The DoD And Intelligence Community. The company was founded in 1968. It was first founded as a defense contractor to supply the government with intelligence solutions. However, the company developed its first POS system ten years later. At the time, the POS system was a solution mostly for the cashier. Nowadays, PAR has multiple solutions for restaurants that maximize the restaurants' operations.

Hardware

PAR’s POS system business was originally a hardware business with its first cash registers. Today, PAR delivers all POS hardware products a restaurant needs. Next to cash registers, PAR delivers tablets for ordering, payment systems, drive-thru products, kitchen display systems, etc. Hardware is not where PAR gets its competitive advantages these days. Now, they are evolving into a software company.

Brink

PAR delivered hardware and software installed on servers in the restaurants until they bought Brink in 2014. Brink is the cloud software that is delivered with the hardware for full integration of POS services. Brink is the platform on which PAR attaches all its POS systems. This includes the payment systems, (mobile) ordering systems, drive-thru systems, delivery, loyalty program, and the back office such as analytics, accounting, and inventory management. Customers can customize the solutions they use and can even integrate solutions from other vendors. Brink is implemented in 12.1K restaurant locations in the US. Brink’s revenue grew over 35% annually from 2017 to 2020.

PAR Payment Services 

PAR Pay is a relatively new product segment. Pay delivers payment devices, gift card programs, and payment processors to restaurants. Payments processing is the key revenue stream of other POS providers such as Toast or Square. Restaurants pay hefty payment processing fees. Restaurants using Square’s POS systems pay 2.6% plus 10 cents per debit card or transaction. Square managed to get a 20-40% gross margin on its transaction revenue in the last couple of years. PAR is planning to enter the market with lower prices, but the above pricing gives an indication of PAY’s revenue potential. The segment is just beginning. Payment processing contracts are often 3-5 years so it could take a while before PAR Pay will have a significant contribution to PAR’s total revenue. 

Punchh

In contrast, Punchh does have an immediate contribution to the total revenue. In 2021, PAR announced that they acquired Punchh, a loyalty solution company for QSR, for 500 million USD. Punchh had several other offers but chose PAR, years after their first contact. 

Restaurants integrate the solutions of Punchh in their POS systems. Punchh makes use of AI to analyze patterns of customer data. These patterns give Punchh the input for campaigns and offers for new and returning customers of restaurants. The campaigns and offers lead to an improvement in customer experience, recurring customers, and higher lifetime value of these customers. Integrating the loyalty solutions in the POS systems makes Punchh sticky for restaurants. Furthermore, due to the solutions of Punchh, restaurants get to know their customers better and are in that way less dependent on delivery companies such as Uber Eats and Doordash. PAR bought the company because it fits right in their strategy to become a full-service POS platform for restaurants. Punchh is now one of the fastest-growing revenue segments of PAR with a 52% CAGR from 2017 to 2020. Their solutions are implemented in 41K restaurant locations and 30% of Punchh's customers do not have one of PAR's products, cross-selling could be a big revenue opportunity.

Data Central

Data Central is the provider of back-office solutions for restaurants. They provide restaurants with inventory management, food management, labor management, and reporting. All solutions to optimize a restaurant's operations. Think of the complex inventory management a chain such as McDonalds has with several locations within one region. The Data Central division has grown from 3 million dollar revenue in 2017 to 9 million in 2020.

Government Segment

The government business is split up between Intelligence Solutions and Mission Systems. The business won a contract of 490 million USD from the US Air Force. As you now know, PAR started first as a provider of intelligence solutions to the US government. However, the focus of PAR has shifted from intelligence solutions to its restaurant business. The company focuses its attention mostly on the restaurant business in public statements. Also, the Government is a low growth and low margin business. Therefore, we expect the company is going to divest its Government segment in order to focus on the restaurant business and use the capital of the sale to acquire companies that would be an addition to its POS platform. The acquisition of the defense contract could be a catalyst for the sale of the Government segment. The CEO, Savneet Singh, is a capital allocator at heart. By waiting until the defense contract was won, the company has potentially maximized the value and is now ready to be sold for the highest offer. Since we think that this division will be sold, we will focus our attention in this thesis on the restaurant business.

Growth opportunity

PAR is active in the US restaurant business. According to the company, the restaurant industry has about 1 million locations in the US. PAR services three major restaurant categories within that industry: fast casual, QSR and table service. This focus group has about 700k to 800k locations. With Brink and Punchh having 12k and 41k locations, respectively, PAR still has a lot of room to grow in its total addressable market (TAM). The TAM is expected to grow in the coming years by 8-12% annually. 

The customization of their products and their full service ensures that PAR mainly targets the bigger restaurant chains. The National Restaurant Association states (https://restaurant.org/research-and-media/research/industry-statistics/national-statistics/) that 7 in 10 restaurants are single-unit restaurants. Sure, there are single-unit restaurants that are serviced by PAR and this customer group could grow in the future. However, PAR does not have a particular way to differentiate itself for the single-unit market. Therefore, we take into account a real addressable market of 210k to 240k locations (30% of the TAM). 

PAR has invested a lot in the development and acquisitions of new products and services. With the addition of new products and services, PAR does not only grow its POS ecosystem but also tries to increase the average recurring revenue (ARR) per restaurant location. When PAR began with Brink it charged 2000 USD annually per location. Punchh receives around 1000 USD per location annually and Data Central 1500 USD. Management wants to increase the ARR per location to 10.000 USD annually. They want to add new products to their ecosystem to achieve the target ARR. Considering restaurants’ low tech spend, an increase of the ARR per location seems to be logical if restaurants can become more cost-effective by using these solutions.

Multiplying the number of locations (210k to 240k) with the target ARR per location would result in 2.1 to 2.4 billion USD of ARR. So, even if PAR does not capture the biggest market share in this segment, the growth runway would still be enormous in comparison to its current ARR of 83 mln.

Competitive advantages

PAR is evolving from a hardware into a software company with a cloud subscription model. Restaurants use the company’s hardware and software to serve clients. Installing the hardware and software does not cause the biggest interruption to business operations. The biggest interrupter is when restaurants have to change to another software system entirely. PAR has all the products and services that restaurants need. Clients of PAR can fully customize PAR’s products. For instance, when a restaurant implements a new POS system with other software, the system should be customized to the restaurants’ needs such as their menu, table management, and order system. Switching POS systems at every location of a restaurant chain with 25 locations could take up to 6 months. Furthermore, restaurants can lose their old data when switching to another POS system.

The stickiness of PAR’s products causes the product to have a low churn rate of approximately 5%. The company is one of the go-to brands in the restaurant POS system industry. The company is, in contrast to its peers within the enterprise segment, fully focused on the restaurant business. PAR is investing heavily in the development of its products and are constantly adding new products to their product range that add value to their customers. Their ultimate goal is to be a platform in which restaurants can operate their front-, mid-and back-office. The systems of PAR can be integrated with other systems if a restaurant deems it necessary.

The POS system landscape

The POS system market has lots of players. POS systems can be used for various industries such as retailers, hospitality, and every industry with face-to-face customer contact. Partly, there are so many players in the POS system market because there are different needs in the different industries and company sizes. A Walmart location has other needs for their POS system than a Mom and Pop diner. The restaurant business can be divided from Mom and Pop diners to the big enterprise restaurant chains. PAR is focusing on the enterprise restaurant segment, chains with more than 50 locations.

Big players in the restaurant POS segment are Toast and Square. Toast and Square deliver easily manageable hardware and software that runs on multiple operating systems. These companies have also featured such as online ordering, payment services, and table management. They are growing rapidly in the market and experts within the industry do like the products. The products of Toast and Square are of high quality and are easy to use. However, these companies generate their revenue from the processing rates of the restaurants’ payments. Toast and Square ask a fixed fee for payment processing. Paying a fixed fee per payment would be not advantageous for sizable enterprises if they can have better fees elsewhere.

The products of the two giants are mainly focused on restaurants with one or a couple of locations. They don’t have products that enterprise restaurants need such as complex ordering and inventory systems, cyber security systems, or extensive reporting systems. Therefore, we have to conclude that PAR is not in the same market as Toast and Square.

PAR receives competition in the enterprise segment from legacy players such as Aloha from NCR and Micros from Oracle. These players deliver POS systems to a variety of industries. Hospitality is one of them. They have vast experience in POS systems. POS experts prefer PAR over Aloha and Micros because their products are outdated. In contrast to PAR, Aloha and Micros do not have an extensive cloud-based platform. Most of their customers still have on-premise servers to accommodate the POS systems. Aloha and Micros are not specialized in POS systems for the hospitality business. This segment is a relatively small revenue stream for these companies. PAR has reinvented itself in the last couple of years. They have spent a lot to build a cloud-based platform from the ground up, thereby accepting lower margins or even negative margins in the short- to medium-term. Large businesses such as Aloha and Micros would likely not accept lower margins in order to reinvent themselves. There are still customers of these legacy players who run their POS systems on the on-premise servers. These systems are very sticky to the integrations, customization, and high upstart costs. However, the cloud has multiple advantages over on-premise based systems. Eventually all restaurants will go over to the cloud. PAR has already been through the pain of setting up a cloud platform. The legacy companies will not switch to the cloud easily. Therefore, forward-looking enterprise restaurants will choose PAR's POS system over the competition due to the advantages mentioned.

Management

Savneet Singh is the President and CEO of PAR since March 2019 and was a board member via the investment company CoVenture since June 2018. Singh is a shareholder with around 1% of shares outstanding. Total insider holding is not much higher, so the top of the company does not have skin in the game in terms of equity capital.

Singh is already known to the crowd that listens to investor podcasts such as Invest Like The Best and Capital Allocators. Singh is not only a CEO of a software company but he is also an investor and was a guest speaker in these investing-related podcasts. Singh clearly expresses his thoughts and philosophy in these podcasts. Singh does not have a particular restaurant or POS system background. However, because he has an investor background he pursues a strategy that would maximize long-term shareholder value.

Singh has a long-term vision and doesn’t mind absorbing short-term blows that could turn into benefits at a later stage. For example, Singh has raised capital that dilutes the shares of current shareholders. However, Singh has invested the proceeds of the capital offerings to acquire companies with products that have added value to PAR’s POS system platform. For instance, Singh has bought Punchh, a company with high revenue growth and margins, plus Punchh’s products add value to customer retention of restaurants.

PAR bought Punchh for 500 USD million in cash and shares last April. ARR was 32 USD million in 2020. Punchh’s revenue grew 52% annually from 2017 to 2020. So, PAR paid 15.6 times Punchh’s revenue. Not bad, when considering that other high growth (>30% NTM) SaaS companies traded around x25 and potential synergies, but still a hefty multiple on an absolute basis.

Singh has experience in investing in software companies. He is transitioning PAR from a hardware company into a true software company. His experience gives him an edge on what works with software companies and he knows how to allocate the company’s capital to that end. Listening to podcasts and reading his quarterly letters shows his clear vision of the future of restaurants and their economics. We think that he is the right fit to grow the company to become the number one restaurant POS system provider in the enterprise segment.

Why not invest?

Clearly, Singh has turned PAR from a mediocre player to a budding star in the POS industry. The analysis until this far argues that PAR has a lot of characteristics to become a fruitful investment. However, we just want to shed some light on some risks a PAR investment would entail.

One of the reasons that PAR is ahead of the competition in the enterprise industry is the years spent on developing a cloud-based platform. The legacy companies are not willing to lower margins in order to develop an extensive cloud platform for their POS systems. However, we do think this might be a stay of execution and they will eventually have to offer more cloud-based solutions. Restaurants will eventually run their POS systems in the cloud. Legacy competitors will be forced to develop their own cloud systems, or buy one, to stay relevant. Either way, they still have to spend a lot of time and money in development.

It might take some years before the legacy players have a cloud platform similar to PAR’s current cloud platform. However, the enterprise segment will be more competitive if the legacy players finally have a rival platform and the larger restaurant chains PAR focuses on will be able to play them against each other. Sure, PAR will probably further develop its products and they might still have a superior product in the coming years. But as of yet, the company has no positive cash flows. It should not take too long before legacy companies catch up and put pressure on PAR’s margins.

Conclusion

The restaurant industry is subjected to technology trends, making restaurants more efficient and cost-effective. PAR is playing a role in these trends by providing the software that weaves restaurants’ operations systems together. Years of hard work by the company has brought PAR into a position where it can take over the restaurant enterprise market. The CEO has a clear vision of the company and he uses his experience in investing and software to execute on it.

These seem excellent points why we should add the company to our portfolio. Nonetheless, we are still a little hesitant. We first want to see some results in terms of growth and margin expansion. There are still some risks that jeopardize the investment case and our threshold to add to the portfolio is high. Results will consolidate our views on the company. Until then, we will put the company on our watchlist.

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Disclaimer: Always do your own research. This is not investment advice and for informational purposes only. Partnership Investing is not a registered investment adviser and may or may not hold securities discussed on this blog.