This Is A Likely Buyer of Aloha POS, And Why It Makes Sense Now

We talked about our concerns with NCR in an earlier post. NCR has been very late to the software and data party and shareholders have rightly voiced their worries. NCR’s torpidity in adopting change will no doubt raise discussions of the perils of managing to the quarter, but NCR has had a good while to figure this out (the first cloud POS companies launched in 2008 and even Micros launched their cloud product, Simphony, for restaurants in 2009).

We concluded our article by saying that an entity that understands data and software could, and probably should subsume NCR’s POS assets and in turn will find much better financial success than NCR has. That NCR recently replaced their CEO with someone steeped in Bank Tech signals to us that they may indeed consider shedding POS assets as the CEO no longer needs to stand behind the seemingly expensive and underperforming acquisitions made by his predecessor. Further, Aloha is also starting to lose marquee accounts to cloud POS upstarts, like Arby’s to Brink POS and Jamba Juice to Toast, and any cash could be used to double down on his Bank Tech vision; according to many of NCR’s analysts the market would view the divestiture as a positive.

So who buys NCR’s POS assets?

It should be no secret that the payments industry is gobbling up the point of sale industry, at least in the US restaurant vertical. The thesis for these actions is actually quite simple:

Payment services are commoditized and easy to churn. A POS is much harder to churn because merchants use it in their daily operations and for fiscal reporting. If payments can be locked into the POS, payments companies will experience lower merchant churn and they can increase their processing rates in the unethical phenomenon known as SMOPP.

We want to be clear here:

Not every payments company that purchases POS assets is operating a SMOPP campaign. There are payments companies who buy POS assets so they may offer their POS product to merchants before another company has a chance to make the sale. These companies do not force merchants to use their payments services and don’t structure the economics in such a way that using competitive payments providers with their POS are outrageously expensive.

But there’s a large payments provider out there who has not yet dipped their toe into the POS waters. That company is Vantiv-Worldpay. Their position has been that, by not having a POS and remaining neutral on processing, they will receive inbounds from merchants who are skeptical about bundling POS and payments from the same provider. This is not an unreasonable strategy though we need more data on how POS and payments bundling plays out.

However, the payments industry has yet to move beyond this initial thesis of POS ownership. At least none of them seem to be explicitly considering what the world looks like in five or more years. So Vantiv-Worldpay might be fine to remain “neutral” under the bundled POS thesis, but what happens as interchange continues to decrease and, eventually, disappears? What will Vantiv-Worldpay do then?

The POS gives payments companies a ton of optionality while decreasing the payments risk. Even though, like payments, POS will eventually become free, there are a number of highly valuable products and services that can be bundled into the POS that increase merchant success, and these tools can earn substantial revenues for the POS company. Without a POS, none if this is possible because you wouldn’t have the necessary transaction data.

This is why we think Vantiv-Worldpay has to do something of consequence in the POS arena, and why we think NCR’s Aloha POS makes the most sense.

First, Aloha is one of the largest hospitality POS systems that’s not currently owned by a payments company. At 75,000 merchants, they’d give Vantiv-Worldpay a sizable stake at the table. Further, the type of merchants that choose Aloha skew larger. These are not the merchants picking up Clover or Square. These merchants have average unit volumes of $1M and expect mature features. Accordingly, these merchants have larger budgets and more to spend on additional solutions, which is a problem Square has reluctantly identified with its customer base.

Second, NCR already has a relationship with Worldpay. Worldpay partnered with NCR to create NCR Merchant Services. The two later collaborated to distribute NCR Silver through Worldpay agents (albeit not well according to insiders). Vantiv-Worldpay could save whatever residuals they’re paying out to NCR in purchasing the Aloha POS assets.

Third, Vantiv, especially after their acquisition of Mercury Payments, was very reliant on the POS reseller channel to feed them deals. Most of those dealers now have different payments priorities after all the POS acquisitions. This undoubtedly makes it harder for Vantiv-Worldpay to find the same level of deal flow. We don’t know how much exposure Vantiv-Worldpay has to US hospitality (we’ve heard 30%) but we’ll be watching their quarterly earnings to see how net revenues are performing.

The pitfall in potential any deal will ultimately be the valuation NCR tries to place on its Aloha POS asset. Recall that NCR borrowed heavily to acquire Radiant, the owner of Aloha POS, and still sits on considerable debt as made clear in the below charts. (It is worth noting that NCR’s debt was effectively zero until Bill Nuti became CEO and embarked on an aggressive acquisition plan.)

Debt is not necessarily bad when you’re borrowing for growth, but NCR has failed to grow at even the rate of inflation. Compare NCR’s revenue from 2005 to that of 2017: a difference of $488 million over 12 years.

That’s a compound annual growth rate of 0.65% while inflation has averaged 2.8% over the same period; if NCR matched inflation they would have done $8,396 million in revenue in 2017. (For reference the CAGR of the S&P 500 over the same period of time was 10%, or 8.5% after accounting for inflation). NCR’s own 10-K visuals show us that the markets are as equally concerned with NCR’s financial performance.

It would seem NCR’s debt is for naught as the amount paid for Radiant (as well as Retalix and DI) was never realized in revenue growth synergies or share price. Actual, not theoretical performance means that NCR might part with Aloha (part of Radiant) at a much lower price than they purchased the asset for in 2011. We’ll explain why.

Companies are purchased on multiples of revenue, EBITDA (profit), and growth. At least if purchased rationally. In its last year as a stand-alone entity (i.e. 2010) Radiant reported revenues of $346.4M and earnings of $21.8 (EBITDA of $47M). 47.7% of these revenues came from hardware, where Radiant was earning a staggering hardware margin of 46.1%: something totally unsustainable in today’s climate, where hardware generously sees a 20% margin at most, and none at worst. For reference Apple, the pinnacle of hardware companies, has gross margins between 30 and 45%.

Subtracting 26.1% out of the hardware margin puts a new revenue of $297M and an EBITDA of -$3M on the asset. Yes: hardware had such high margins it appears to be how Radiant was earning a profit. Not exactly a good look if your software and services margins are negative… it just shows how much you’re not a software or data asset.

Currently EBITDA multiples are at a 10-year high. In 2010, when NCR approached Radiant, they were much lower.

Still, NCR managed to pay nearly 3x market rates for Radiant, shelling out 23x EBITDA and recognizing $809M in goodwill. Goodwill is basically a premium a company pays for something that isn’t reflected in the underlying financials.

But this level of goodwill would certainly explain why shareholders and analysts were uproarious over NCR’s acquisition prices at the time. NCR sold a vision of turning these assets into software winners for the company…. but today, the market doesn’t seem to be buying the story. NCR is currently trading at a 6x EBITDA multiple while Diebold, a competitive ATM manufacturer, is trading at 8x. For reference, “blue chip” hardware companies like Honeywell and IBM are trading at a 14x and 10x multiple respectively while software companies like Facebook trade at 20x.

This could mean NCR is cheap enough for someone to acquire and break apart. It also means Aloha, if fairly priced, could be had for somewhere between $150M and $350M since the restaurant segment, something Radiant Systems defined as Hospitality-Americas, represented ~60% of Radiant’s EBITDA at the time of acquisition. We think that’s a great option for someone looking to get into restaurant POS.

Why?

Simply stated, it’s infinitely cheaper to acquire market share in brick and mortar by purchasing assets than it is to grow it organically. The alternatives in hospitality POS are not overly attractive for a material land grab, which is what Vantiv-Worldpay would need. Sure, there are newer POS players starting to find their legs, but nobody sans Micros commands a similar marketshare to that of NCR on one product stack (Shift4 and Heartland and battling the alignment of several legacy POS systems).

Even an up-and-coming POS solution like Toast would be expensive given the money they’ve raised: after their soon-to-be-announced round placing them at a unicorn valuation, Toast will be 3x the price of Aloha POS with roughly 15% of the merchant base – or 20x the price on a unit basis.

We would strongly prefer to invest in modernizing a POS product versus acquiring market share; the latter is way more expensive. And it’s not as if the Aloha brand is broken. Yet.

So the question becomes when will Vantiv-Worldpay act. Does another firm swoop in and take Aloha/Radiant from NCR before Vantiv-Worldpay has a chance to figure it out? Does Vantiv-Worldpay wait until there’s clear evidence in their own numbers that bundled POS and payments is the way of the future – at least for the time being? Does Vantiv-Worldpay get out of hospitality altogether? Or do they look at Aloha and take an honest assessment of their culture and human capital and think about the difficulty in undertaking anything software-related? These questions are critical to the timing of any serious action.

We will still contend that the bundling experiment is only the first of many dramatic shifts to come. Payments companies need to be very much in bed with POS to survive the coming storm. If they don’t figure that out they will be lost at sea.