This is a continuation from our earlier series.
Definitely some juicy bits in here. In fact, perhaps the most meaningful points of consideration are in the back half of this series.
Toast goes multi-vertical
This is perhaps our favorite slide and it invites a ton of questions.
Toast is going into other verticals.
So many questions.
First, why would Toast go into other verticals if things were so rosy in restaurants?
Toast has only penetrated a small percentage of the US industry according to their own numbers, even if we don’t think those numbers are accurate (13% of US restaurants according to Toast).
Doesn’t the move into other verticals set off warning sirens about Toast’s potential in the US restaurant vertical? It’s not as if there isn’t a ton of competition from sophisticated competitors (e.g. Shopify) in retail.
(BTW, Square needs to seriously reconsider their passive, product led growth strategy if Toast is going to aggressively pursue direct sales in retail verticals. They’re asleep at the switch and it’s why they should acquire SpotOn.)
Second, are these merchants going to accept the high payment rates that Toast has foisted upon restaurants?
We find it hilarious that restaurants, the world’s best super-genius-negotiators by their own bragging, have handed Toast so much money in payments margins that Toast is able to go into new verticals.
Investor: So what’s the real strategy here? We all know restaurants are the worst customers in the world…
Toast: That’s just it: they’re absolutely terrible and everyone avoids them. But they’re morons! We can build an amazing cash cow by bleeding them through payment processing and they’re too dumb to do anything about it!
Investor: Take my money!
Toast is going to find out they can’t juice payments in many of these other verticals, however.
For example, independent convenience stores carry a banner from a major oil company most of the time, and there’s very little payments margin there since the major has contracted payments at scale at the pumps (called the forecourt), where most of the volume gets processed.
We don’t think Toast’s model works if they can’t fleece SMBs on payments.
Toast is really taking price
Toast’s economics also beg questions.
Toast grew ARPU 37% (16.5% CAGR) from 2021 to 2023.
Inflation was 4.7% in 2021, 8% in 2022, and 4.1% in 2023.
In other words, Toast is growing 3x the rate of inflation (although technically inflation is much, much higher if you use the same methodology we used in the 1980s – Larry Summers, a relative leftist, showed how real inflation in 2022 was 18%).
Is Toast growing ARPU by owning more of the restaurant tech spend (yes) or from increasing prices (also yes)?
On the latter, Toast says they’ve increased SaaS PRICES 50% in ~3 years:
Let’s be clear that it’s not revenue they’re talking about, but PRICES. That means the same item from Toast was 50% more expensive in 2023 than it was in 2020.
Toast believes they can imminently reach $30K in SaaS ARPU given all that they offer.
That’s really wishful thinking.
Remember, retailers cannot spell ROI, and every dollar out they view as an expense, not an investment. Accordingly restaurants spend a laughable 20-40 bps of their revenue on technology.
For Toast’s average merchant, this is $3-4K/year in explicit spend (we’re not talking about the money Toast can steal in the payments stream, but the above-the-table software spend).
Even Toast’s own analysis shows that merchants won’t take more software, irrespective of ROI.
Toast’s payments margins surprisingly haven’t moved
Toast’s payments take rate has not budged at all.
Not to say this won’t change, but Toast either is incorrectly recognizing payments margin from an accounting perspective or they’re being honest and not cranking rates.
Toast has been transparent in widespread rate increases and we’ve also seen Toast throw software fees into the processing stream, so it’s a mixed bag.
We wouldn’t put it past Toast to concoct some creative ways to reach their growth targets using the payments processing stream as their weapon of choice.
It’s just so easy.
For example, read this diabolical surcharging play that they’ve concocted.
In fact, we highly doubt that Toast’s processing take rate has been stuck at 45 bps… it’s more likely that Toast is actually making 80 bps or higher on payments but creatively labeling that revenue as software to engineer a better multiple.
Toast’s growth projections look… odd
It’s really weird to see Toast mention that they’re aiming for 40% margins while referencing the rule of 40 on the same slide… so does Toast plant to satisfy the rule of 40 using margins and eschewing growth?
It’s eerie.
Either we’re not understanding what they’re trying to explain, or someone needs to dig deeper.
But when you’re already 2.6x the cost of predecessors, you’ve got a lot of margin to play with.
Just worth thinking about.
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