Government interference is killing a lot of jobs. We estimate that quarantines perpetuate at the federal level through June, with state and regional quarantines well into July and August, or perhaps longer. None of this explains what happens when we have a viral rebound either: do we have quarantines on quarantines until vaccine or herd immunity? Nobody at the federal level is willing to answer these truths.
Meanwhile, the economy is in rapid decline. And there’s been no more precipitous drop than on main street, where small and medium businesses operate on low margins and with no balance sheets. It’s here that upwards of 60M US jobs are at stake, and they’re fading quickly. The first week under quarantine wiped 3.3M jobs, and nobody on Wall Street predicted the 6.6M jobs lost the following week.
That’s because politicians and pundits are simply out of touch with reality. They are too far removed from throwing on an apron and going to work at 4 AM. But that doesn’t make reality any less biting.
Many main street merchants picked up POS systems over the past five years, especially as payments processors interceded the software buying process. The rules of POS changed, and easy capital made it possible for POS companies to offer “free POS” in an aggressive attempt at buying market share with a bundled payments model. And now the strategy that was riding on the blade of a knife has finally found its first serious knick.
Of all the POS companies out there, we can’t think of one that was more levered than Toast. Toast built and scaled a model that worked well so long as money was easy and the market was up and to the right. COVID-19 changes that world, and Toast’s world may well fall apart.
By our last count Toast had 30,000 merchants. It’s fair to assume half of those were “free POS” systems, whereby Toast wrote an estimated $10,000 per merchant on its own balance sheet. Toast grew even faster in more recent years thanks to the glut of cheap capital, meaning that many of those 15,000 “free POS” systems have not been around long enough to have paid back much of the capital loaned by Toast.
In other words, Toast has a lot of debt on their balance sheet.
How much debt? We built a model that estimates Toast’s annual merchant growth and total merchant count at year end. We assume 50% of all net-new merchants are “free POS” merchants that put $10,000 on Toast’s balance sheet. We also assume that the merchants pay back the “free POS” loan in 24 months, yielding the amount of “free POS” loans outstanding.
Pre-COVID-19, we estimate that Toast had $95M on their balance sheets. But it gets worse.
Toast has high exposure to SMB and table service merchants. SMB merchants are more likely to sign up for “free POS” because they’re too dumb to know how math works, and table service merchants are a better fit for Toast because they average higher revenues, and Toast is estimated to make 70% of their revenues from payments processing, so going after merchants who process larger volumes of transactions works well for their model.
SMBs have no balance sheets. And unlike QSR and fast casual merchants, table service merchants don’t lend themselves to delivery-only businesses, which is all that’s persisting post-COVID-19. This means Toast is going to get whacked doubly hard: SMBs who don’t have a balance sheet to survive more than a 30-day quarantine, and table service merchants who won’t be seeing any revenue to sustain operations.
Which means that Toast needs to be modeling that they’re going to have to write off most of that $95M in “free POS” loans. Whoosh.
On top of that, Toast has built a business that was willing to burn $100M a year to chase growth for their “free POS” model. Figures we saw put Toast at spending $300M a year, earning a bit over $200M on their payments and software revenues, but net-net losing $100M a year. On a monthly basis Toast was spending $25M a month and earning $17M in revenue. How long can they keep this up?
Well, remember that 70% of their revenues were based on payments. That means of their $17M in revenue, $12M has practically evaporated. From our data, table service is down 80-100%, and QSR is down at least 50%, mostly buoyed by larger chains. Even if you assume Toast had a 50/50 mix of table service and fast casual merchants, their payments stream is not generating more than $4M a month in the best case. The other $5M of SaaS revenues are also eroding, with 35% of restaurants now shut down. Toast has graciously waived SaaS fees, but that doesn’t help their revenues.
So Toast is likely not earning more than $7M in revenue per month, and that’s against spend of $25M, for a net loss of $18M monthly. Let’s graph out this cash position assuming the full $400M from their last raise didn’t have covenants (i.e. Toast would need to hit x in revenue to release a traunch of $100M of the $400M round). We start with $305M because we need to subtract the $95M of “free POS” loans that Toast will need to write off as those merchants go bankrupt. (Note: Toast has buoyed their balance sheet with a $100M debt instrument, but we’re not including that in this analysis because that has to get repaid eventually.)
The biggest drag on Toast’s cash position is their headcount. With 2,500 employees at an average annual cost of $100,000 per year, that’s $250M in annual expenses. Hard to justify that when the market literally isn’t open for business.
Toast will likely not be able to employ “free POS” when the market reopens without having high conviction in consumer spend. We think we’re headed for a global depression if governments don’t open up economies, which means restaurants will be just about the last place consumers go to spend their limited capital. Most restaurants that close will stay closed, fewer restaurants will open, and those that do will be facing more risk than a merchant during the pre-COVID glory days of “free POS”.
All this to say Toast knows what it’s facing and will have to weigh firing the majority of their sales staff shortly. After sales people are left go (who are at least half of Toast’s payroll), Toast will look to slash engineering and corporate overhead. Don’t need massive offices either when your headcount shrinks by half to two thirds, so expect new digs too.
More broadly, Toast is no longer a $5B company, and their hopes of IPO have been shattered. We anticipate Toast’s revenues falling by at least 75% when the quarantines are lifted: 50% because at least half their merchants go out of business (they are SMBs with no balance sheets), and the other 25% because consumer restaurant spend is not going to rebound any time soon. Until there’s a vaccine, people over 55 are going to stay home, and that’s 36% of restaurant spend.
Toast was already being given a generous 20x revenue multiple, but they’re not growing 100% anymore. Which means Toast will most likely be marked-to-market as a $500M company (10x $50M in revenues, which is still really generous given unknown growth rates), a 90% reduction from the $5B valuation.
As a Toast employee, if you were granted shares anytime after Toast was worth $500M – likely after the fall of 2017 – your shares are underwater, and depending on the specific price, in effect, worthless for what’s looking to be a long time.
If Toast acts fast by firing employees and concentrating on burn, they’ll grow to be a billion dollar enterprise again. But it could take years… nobody know how this market will recover. Toast has enough money to wait it out, and it looks like they’re already making moves to cut staff by 50% to give themselves the best possible chance.
Still though, Toast is probably the luckiest company to have have ever graced the landscape of brick and mortar. Think about it: not only was the “free POS” business model impossible at any other time in American history, but Toast closed a $400M round of funding right before it would have been impossible to raise capital. In fact if Toast hadn’t closed that $400M in all likelihood they would be declaring bankruptcy in 2020 from the bad debt on their “free POS” loans.
Like we said before: life is short, and it’s better to be lucky than good. But how many lives does Toast have left? Maybe when Toast’s employees realize that their shares will never clear their issued price another life will be scratched off Toast’s tally.
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