When companies file to go public they have to disclose a lot of information in a form called the S-1. The benefit for us outsiders is that we’re given real data to analyze. Since Lightspeed is the first of the more-funded cloud POS companies (they’ve raised $292M) to go public we couldn’t help but peel back the layers to see what we might learn.
In the good ol’ days of 1999 companies could file to go public with little more than an idea. That’s changed and today companies need to be earning $100M in annualized revenue to entice any buyers. Our first thought is that Lightspeed raised the amount of capital they did to hit this milestone.
At the highest level Lightspeed did $72M in revenues over the last 12 months. Lightspeed technically “lost” $99M but really only $35M as far as we’re concerned – the difference between the two was a weird accounting consideration for its redeemable preferred shares, which when marked to market rates is a loss of $64M, or the difference between the $99M “loss” and the $35M loss. Taking it one step further one might only consider the Operating Loss since the rest appears to be tax expenses which come with their own nuance. See the below financials.
We next need to examine growth. We get Lightspeed is losing money, but how fast is it growing?
Lightspeed’s current monthly ARPU is $200, which isn’t horrible. Their location count is growing at a healthy 21% CAGR as well. We’re even going to say that this location growth is starting to come at the expense of legacy POS companies that downplayed the threat of cloud POS.
How did we arrive at that conclusion? Well, we can examine Lightspeed’s growth in GTV, or gross transaction volume, to see that GTV is compounding faster than revenues, meaning that each merchant Lightspeed brings on is getting larger. While Lightspeed’s average merchant appears to only be doing ~$300K of annual revenue today, that’s growing pretty quickly. And by the way, if this trend of moving upstream to larger merchants looks familiar, that’s because you’ve seen it before with Square, who now counts more than 20% of their merchants as processing greater than $500K annually.
But back to growth; remember the investor’s rule of 40%? Growth + profit margin should equal 40%. So if you’re growing 100% YoY you can have -60% EBITDA margins and investors will feel okay. Lightspeed’s revenue CAGR is 36%. This means Lightspeed needs profit margins of 4% to reach the 40% threshold. Instead, they have profit margins of -20% (we’re using a negative EBITDA of $14M here) for a total of 16%. Not exactly what investors crave, but POS is really f*cking hard if you haven’t already figured it out.
Now, given that POS has proven so difficult, the logical person in us would say that Lightspeed should double down and focus on POS. It’s obvious that they’re not satiating the rule of 40% and there’s nothing more distracting than a seemingly infinite number of bolt-on products to build, sell, and support on top of the POS. Yet Lightspeed’s answers come in two forms here.
First, Lightspeed is adding payments. Lightspeed says, “SMBs are increasingly looking for fully-integrated software and payments solutions,” which we find to be accurate since bundled POS and payments processing offers tighter integration. In this bundled (but not locked-in) scenario merchants do opt for one-throat-to-choke as payments is commoditized and there’s no reason to look for a “best-of-breed provider” because there is none in payments and it adds another vendor.
But even more important to Lightspeed are the economics of payments processing.
Lightspeed Payments also allows us to capture a larger portion of the overall economics of a payments transaction. Historically, we have referred customers to various payment processing partners, from whom we would generally receive a small percentage-based referral fee of approximately 0.25% of electronic transaction volume processed. With Lightspeed Payments, we intend to price our solution at approximately 2.60% of the electronic transaction volume processed on a gross basis, and we are targeting to net approximately 0.65% after accounting for network and interchange fees and other direct processing costs.
Page 6, Lightspeed S-1
Yowsers. 65 basis points (bps) is extremely high. We get that Lightspeed’s merchants skew smaller, but 65 bps is still ridiculous. In some sick form of irony the section directly following this one is one called “Support growth of existing customers” that says,
Our success is directly linked to the success of our customers. We provide our customers with the tools to successfully grow their businesses which in turn benefits our platform growth.
Page 6, Lightspeed S-1
Uh, you can’t talk about sodomizing your customers for 65 bps then pronounce that you’re helping your customers grow. If you wanted to help them grow figure out how to get your payments margin to 0. Payments are commoditized, add no value, and are an utter joke. But boy are the margins sweet.
Second, Lightspeed believes it will bolster its financials with homegrown bolt-ons.
We believe SMBs need a comprehensive solution that seamlessly integrates their front-office, back-office and payment requirements to effectively interact with customers across all channels, efficiently run their business, leverage value-added data and functionality to enhance their competitiveness, and accept various forms of payment.
Page 3, Lightspeed S-1
This is not the wrong conclusion, but it’s wrong when you believe you’re the only party that should provide these solutions… which is how Lightspeed is leaning:
We also believe that ARPU for our solutions will continue to increase as customers adopt more of our current portfolio of solutions, including payments… We provide our customers a hub of end-to-end capabilities, including full POS capabilities, payment processing, inventory management, multi-location connectivity, customer management, loyalty, analytics and reporting
Page 18, Lightspeed S-1
Maybe Lightspeed has neglected to study Micros, NCR, or HotSchedules for starters. Each of these companies has found it increasingly difficult to compete on their core solution as their focus broadened to compete with everyone in brick and mortar. Lightspeed did provide some data in this department which we must closely analyze to prove the point.
Lightspeed calls its bolt-ons “modules”. As can be seen in the below chart Lightspeed is selling more if its modules to its customers: at the end of 2018 31% of its customers were buying at least 1 module.
Now we get to the worrying part.
Our additional platform modules, all of which come at an additional monthly charge, are designed to scale with our customers. We expect our customers to adopt additional modules over time, as their businesses grow. As at December 31, 2018, approximately 31% of our customers were purchasing more than one module, compared to only 5% as at March 31, 2016. This was supported by the launch of our eCommerce, analytics and reporting modules in Fiscal 2017 and Fiscal 2018.
We will continue to add more solutions and modules to our platform, which will allow us to deepen our relationships with existing customers and attract new ones. Since our founding we have successfully added innovative capabilities for payments, eCommerce, analytics and loyalty. Our internal process for developing new solutions is based on frequent monitoring of our broader ecosystem, specifically identifying certain features and functionalities that are being used by our customers but provided by third parties. Our research and development team then considers the merits of developing these solutions internally versus having them continue to be offered by others within our ecosystem.
Page 6, Lightspeed S-1
While Lightspeed has been adding more modules, look at what’s happening to their engineering (R&D) costs over their last three fiscal years.
Isn’t it odd that R&D fell for fiscal year 2018? For comparison, there are companies that solely focus on the modules/bolt-ons that Lightspeed started offering and these companies spend substantially more in R&D because they need to stay competitive (i.e. they can’t rely on a locked-in POS model to prevent merchant churn). For a specific example Punchh, a loyalty company, appears to spend nearly $10M in annual R&D costs. Is Lightspeed going to do the same for ReUp, the loyalty solution it acquired then rebranded at Lightspeed Loyalty?
But that’s not all. Don’t glaze over our comment in the above paragraph about the locked-in nature of POS to prevent churn of modules/bolt-ons.
Furthermore, many traditional POS systems are closed in nature and lack the flexibility to effectively integrate external solutions and applications, preventing SMBs from accessing the latest technology and hindering their ability to adapt to today’s changing environment. These challenges have historically prevented SMBs from leveraging their POS system by adding value-added functionalities, further curbing their competitiveness.
Page 16, Lightspeed S-1
Once Lightspeed acquired ReUp one of thier app store loyalty partners told us that Lightspeed shut off their API
“Our existing Lightspeed customers can still use our marketing tool but Lightspeed has banned us from onboarding and new Lightspeed merchants with their API,” shared a source.
If true this is like NCR 2.0. This also helps to explain why Lightspeed’s net dollar retention rate might be over 100%: wherever possible, they kick out third party bolt-ons and force merchants to use their own solution.
Worringly, Lightspeed doesn’t seem to want to slow down this practice at all. To this effect, the use of their proceeds from the IPO will be, “expanding our customer base; accelerating the rollout of Lightspeed Payments; supporting the growth of existing customers; expanding our solutions; and selectively pursuing acquisitions.”
Seriously, this should be very concerning for any Lightspeed merchant or third party partner if true: Lightspeed will slowly choke out third party offerings until they monopolize the whole stack, leaving customers with no choice, inferior offerings, and higher costs. Monopoly 101.
Unfortunately Lightspeed cannot comment in this until after the IPO.
Lastly, we want to point out how Lightspeed is using data to sell merchants, and their odd perspective on their business model.
Our acquisition strategy for new customers is highly refined, scalable and completely virtual in approach. We do not employ a “feet on the street” sales team, instead leveraging our expertise in using marketing techniques to drive inbound interest to our solutions and a virtual sales team to qualify and finalize contracts with our customers. We believe our sales and marketing approach is a compelling strength of the business and is a core differentiator as compared to our competitors who often employ more costly and less data driven approaches to reaching new customers at an appropriate cost of acquisition.
We also maintain a sizeable support contingent via a third-party provider located in the Philippines
Page 22, 127, Lightspeed S-1
This may or may not prove sustainable if Lightspeed wants to get into larger restaurant merchants. While retailers are much easier to support (shorter hours of operation, less chaotic operating environments), larger restaurants still prefer local service. Lightspeed, like Square, might find friction in this 100% remote model as they move upmarket.
We do not believe that any of our competitors offer an integrated solution including all of the features and functionalities of our products.
Page 25, Lightspeed S-1
And despite what Lightspeed pronounced above, their competitive differentiation is not accurate. There are many POS companies that offer integrated solutions like bundled payments and APIs, and many more that have failed at trying to monopolize the entire stack themselves.
In our estimate the bet on Lightspeed comes down to their ability to expand ARPU at each merchant site. This takes larger merchants with budgets for modules, and modules that are sufficiently competitive. We’ve never seen a POS company offer a best-of-breed module that they’ve built themselves, which is why we suspect Lightspeed has only found 6% penetration of their second module over a 4-year window (we suspect the 20% penetration of the first module occurs because they’re defining a product like ecommerce as a module even though it’s often included in core retail POS – i.e. it’s a necessity in today’s market). If the modules were better, the attach rates would be too, and we’ve proven that ourselves.
