With so many acquisitions being made in the payments industry we’ve heard from numerous sources now that NCR is looking to divest Aloha – the restaurant POS asset under Radiant, a company it bought for $1.2B in 2011.
We don’t know if there’s any truth to this, but we think, if anything, NCR needs to sell its hardware businesses and keep the retail and hospitality software units. Or, realistically, sell the software opportunity to someone else. To understand why, we need to better understand NCR.
NCR began as the National Manufacturing Company in 1884 where they focused on selling cash registers to merchants. By 1911 it acquired 80 of its competitors and owned 95% of the cash register market. The federal government found NCR guilty of the Sherman Antitrust Act in 1912, and NCR’s executives were sentenced to serve time (though they never did).
NCR kept acquiring and iterating on hardware solutions, getting into mainframes and computers throughout the last half of the 20th century.
In 1991 NCR was purchased by AT&T for $7.4B and merged with Teradata. AT&T was NCR’s largest customer at the time, so AT&T just as well assumed they should save the money and buy them.
But like all hardware businesses not named Apple, NCR continued to find trouble. By 1993 the NCR-Teradata business unit was losing $1.25B on revenue of a little over $7B. For those that follow business trends, you’ll note that this was the same time IBM brought in Lou Gerstner to change the company from a hardware business to a services business. The reason? Asia had entered the global markets and hardware was rapidly becoming commoditized.
The losses mounted and AT&T spun out both Teradata and NCR as a single unit (named NCR) in 1997. But that didn’t stop the acquisitions. NCR continued to acquire more companies: Compris Technologies, a restaurant software company; and Ceres Integrated Solutions, a CRM software. NCR also divested of their computing hardware business. After a decade of partnership NCR spun out Teradata in 2007.
The chart below shows the performance of both Teradata and NCR since the Teradata spinout in 2007.
By pure coincidence they happen to have the same market cap. Since market cap is a reflection of equity and not debt, we need to look at enterprise value, or EV. NCR’s EV is $7.2B while Teradata’s EV is $4.4B. Teradata, however, does receive a 3x premium on their price to earnings (P/E) and has 1/3rd the number of employees who produce the same market value as that of NCR.
Why? Let’s answer the question another way.
AT&T purchased NCR in 1991 for $7.4B. 27 years later, NCR is only worth $7.2B in today’s dollars. For reference, one dollar put into the S&P 500 over those same 27 years would have earned $5.39: a return of 539%.
So…
If NCR had kept pace with the market it would be worth $38.77B today!
Obviously NCR has not kept pace with the market. This implicitly helps us answer why Teradata receives a P/E premium: because it’s not a hardware company!
NCR has had an immensely difficult time moving away from its hardware roots. Even though NCR’s most current CEO, Bill Nuti, has increased the company’s software revenue from $0 in 2010 to $1.8B in 2016, none of that was organic. In fact, some in the investment community have been incredibly vocal over how that software revenue has been generated.
It started with a strategic review of the company in 2015 as NCR traded at a 10-year low. This is code for, “investors are not happy with returns and the company needs to do something material.” There were several ideas floated, including a large share buyback (i.e. the company has no clue how to improve itself), a full sale to a private equity company, or a spin off of assets.
It turned out that no private equity company thought NCR was worth buying, so Blackstone placed a PIK (payment in-kind) worth $820M. This expectedly lifted pressure from NCR’s leadership but not everyone was sold on the nature of the deal: both equity investors and credit rating agencies were unconvinced this was a win-win, only furthering NCR’s debt-fueled troubles.
NCR paid $1.2B for Radiant, with $1.1B of that financed with debt. Radiant reported $21.8 million in earnings atop $346.4 million in revenue for 2010 – not exactly the profit margin lauded by software companies. NCR acquired Retalix for $650M in cash; Retalix’s last quarterly reporting showed $236M in revenue with $13.7M in earnings, another low margin buy. Lastly, NCR purchased Digital Insight for $1.65B, which would rightly upset investors when you comb through the details.
Digital Insight (DI) was on pace to do $325M in annual revenues in 2013. In August of 2013 Thomas Bravo, a private equity group, purchased DI for $1.025B. In four months they turned around and sold it to NCR for $1.65B, earning an annualized rate of return of 150%, which is nothing short of astounding on a deal of that size. Investors looking at these data points have an absolute right to question the purchase price tendered by NCR: was it a deal pushed through to show software growth at any costs?
NCR has changed its public reporting metrics from business divisions (hospitality, retail, and finance) to revenue types (software, services, and hardware). This makes it very difficult to understand just how fast NCR’s software revenue has grown under Nuti’s watch, and if it’s exceeding S&P growth rates. Without a full list of acquisitions and revenue sources it’s disingenuous to state a conclusion here, but there are some systemic problems with NCR’s composition.
NCR’s biggest division is finance – or more specifically banking. In 2016, when divisional revenue was last reported, finance accounted for over half of NCR’s revenues. NCR makes ATMs that cost around $40,000 a piece in a world that is increasingly closing bank branches. One could argue that bank branches will be replaced with smarter ATMs, or that Rest-Of-World is still behind the West in banking infrastructure and thus needs ATMs, but that’s discounting the fact that currency continues to move digital. Case in point, China (see below) and Kenya have showed precisely what happens when banking infrastructure is lacking: they go straight to software and avoid costly hardware.
So while NCR is busy working on its commoditized hardware businesses it’s not focusing on software, nor on the even more valuable underlying transaction data. The market gifts software companies a 5x premium over hardware companies, so any leadership hesitating to fully embrace an aggressive move toward software should be shown the door. Yes, NCR has publicly stated its goals (copied below) are to become a software company, but is it really executing on that path? Ask anyone using an Aloha POS and they’ll tell you NCR’s hardware is twice the price of analogous POS hardware and they haven’t seen a cloud replacement for Aloha software despite cloud POS systems having been in-market for nearly a decade at this point. That sounds a lot like software is the tail of the hardware dog.
As mentioned, here are NCR’s goals:
- Sales Enablement – Providing our sales force with the training, tools and processes necessary for consultative selling, supported by a strong solutions management function that innovates the way in which we go to market, and expanding our organization of channel partners.
- Services Transformation – Driving improved services performance by focusing on a higher mix of managed services, improving our productivity and efficiency, expanding our remote diagnostics and repair capabilities and creating greater discipline in our product lifecycle management.
- Evolving our Business Model – Continuing the shift in our business model to provide innovative end-to-end software platform solutions for our customers, with best in class software support while keeping an efficient cost structure to create competitive advantage.
- Investing in Innovation – Optimizing our operating model and prioritizing investments in areas with the greatest potential for profitable growth, such as cloud solutions and professional, managed and other services.
- Cultivating our Culture and Team – Organizing and recruiting with an eye toward the future, and investing in, training and developing our employees to accelerate the delivery of our innovative solutions and to focus on the needs of our customers and changes in consumer behavior.
NCR has hired very capable mid-level managers to execute these stated desires, but if there’s no cultural understanding, and thus no support from the top, then the goals will never be met. So long as NCR’s leaders are busy chasing quarterly numbers and refusing to invest in modernizing the company’s core products they’ll miss the shift to software and data – which are an order of magnitude larger than their hardware business.
That’s why if we were to make a prognostication we would bet on a company with a software and data culture to absorb the point of sale divisions from NCR, leaving NCR with its hardware businesses. We think either Facebook, Google, or Amazon would be the right owners, and here’s why.
These companies are already building inroads to local merchants. For Facebook and Google that’s programmatic merchant advertising, and for Amazon it’s selling merchant wares (though Amazon has a quiet $1.7B ad business themselves). All of these tech companies are offering some facilitation of mobile ordering and are very keen on collecting merchant and customer data to better understand outcomes.
And what do NCR’s POS assets have? Highly valuable transaction data.
If any of these tech companies were to acquire just Aloha from NCR they would 10x the value of their purchase in 2-4 years, much faster than NCR will ever be able to execute with its proven track record of deprecating returns. The best thing for NCR is to either:
A) Sell their POS assets to an entity with a data culture that can execute on the potential, or
B) Empower their mid-level managers with real decision-making, likely by finding new executive leadership who better understand data and software.
The former is much less messy and doesn’t put NCR’s existing leadership in a position where they must question if they have the skills or knowledge to be at the helm of the ship. So if nothing else than for politics, we think it very reasonable that NCR might be looking for a home for its POS divisions. Debt financing for acquisitions is cheap, POS and payments are in turmoil, but most importantly data companies know just how much NCR’s POS businesses could be worth under the right owner.
Sometimes rumors just make too much sense not to have a sliver or truth. Yet there might be one particular company that beats the data companies to the punch… we’ll reveal our thoughts on this soon enough.
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