What's up guys and welcome back to wall street millennial on this channel, we cover everything related to stocks and investing last week, restaurant technology company toast ipo'd, with a 40 ipo price, giving the company a 20 billion valuation, the share price surged immediately as high as 62 Dollars per share before giving back some of those gains. It now sits at about 56 dollars a share, giving the company a market cap of 28 billion dollars still well above their ipo valuation. It's not every day that we get a 30 billion dollar new ipo. So what is toast - and why is it getting so much attention from investors in this video, we'll go into what the company does, what their prospects are going forward and whether or not they're overvalued keep in mind that we are not financial advisors and this video is For entertainment purposes only make sure you do your own research and consult with a professional before making any investment decision.

Toast is a technology company which creates an end-to-end point of sale or pos system for restaurants, they're, basically, an operating system for a restaurant which allows them to manage things like payments, pricing, menu options, loyalty, programs and other things you can think of them as somewhat similar To square and that they are a pos system for small businesses, but while square focuses on all types of businesses, toast focuses exclusively on restaurants and tailors their product offering to fulfill their needs. This includes things like managing the menu and customer loyalty programs. This is something that square doesn't do. Peter thiel says that startups should start off with a narrow focus, so they can dominate their niche and concentrate on serving a specific set of customers.

This is exactly what toast is doing. Toast was founded in 2012 and their growth over the past few years has been remarkable. They only reach 1 000 restaurant installations in 2015, but since then they have increased 48-fold to 48 000 restaurants. In the first half of 2021, they have three ways of generating revenue.

First, they charge monthly subscription fees for the pos kitchen, display system, invoice management and other services they offer. Secondly, they charge a take rate on all transactions paid on the toast pos. These fees include a percentage plus a fixed amount per transaction and thirdly, they generate revenue by selling the toast pos hardware, such as the register terminal to the restaurants, one of the most important growth metrics to look at for payment and software companies, such as toast, is Annual recurring revenue or arr arr is their subscription and transaction revenues converted to an annualized basis. For example, if they charge a restaurant one hundred dollars per month, they record one thousand two hundred dollars of ar.

As you can see, toast's arr has been growing rapidly. It increased more than fourfold from 110 million dollars in the first quarter of 2019 to almost 500 million dollars in the second quarter of 2021., the vast majority of their revenue comes from financial technology solutions, which is the take rate that they charge on transactions. This account for 82 percent of total revenue in the first half of 2021., subscriptions represent 10 of revenue. Hardware sales are 7 of revenue, and, finally, professional services make up.

One percent professional services is when toast sends it personnel to go to customer restaurants to help them set up toast pos from a margin perspective. Their subscription segment is the most profitable with a 66 gross margin. Software subscriptions are highly profitable because there is very little marginal cost. Financial technology is less profitable because they have to pay fees of third-party payment processors to process the transactions.

Hardware and professional services have negative gross margins. This is to be expected, as they use this. As a loss leader, they sell the pos hardware to restaurants and help them install it below their own cost, but they'll make back this investment over time as the restaurant pays them transaction and subscription fees, while their revenue growth is impressive, they are still losing money for The first half of 2021, they made 704 million dollars of revenue after subtracting their cost of revenue and operating expenses. They made a loss from operations of 57 million dollars as they increase their scale.

Their operating costs will become a smaller percentage of revenue and they should be able to become profitable. But it's important to note that their gross margins of 22 percent aren't all that high. This is mainly because they have to pay a significant portion of their transaction-based revenue to third-party processors. This will continue to be a drag on their gross margins, even as they grow so they'll never be insanely profitable.

We know toast, has differentiated technology and is the clear market leader in restaurant technology. This is reflecting their strong growth historically, but the question is whether or not they can grow into their current 28 billion valuation and if so, how long will it take toast mainly caters towards small family-owned restaurants, with their average customer only operating 1.65 locations? Large chains like olive garden, invest in more sophisticated pos and restaurant management systems, so they don't use toast. According to finance online, there were about 350 000 independent restaurants in the us in 2018.. While this number may have decreased during the pandemic, we could assume they will rebound to pre-covered levels eventually.

So 350 000 restaurants seems to be a good estimate of toast's total addressable market. Currently, toast serves 48 000 restaurant locations and they made about 700 million dollars of revenue in the first half of this year. We can assume the full year of 2021 they'll make about 1.5 billion dollars. This translates to thirty one thousand dollars of revenue per restaurant.

There are about three hundred fifty thousand independent restaurants in the us they currently have about fourteen percent market share, but they are growing they'll never get to one hundred percent market share because some restaurants will use square or other competing payment technology providers. Let's assume they can eventually get to 50 market share. This is very optimistic and will probably take at least five years to happen. In a best case scenario, this would give them 175 000 locations and 5.4 billion dollars of revenue.

Their gross margins will never be that high because they have to pay a huge chunk of their revenue to third-party payment processors. Let's assume a 30 gross margin at scale, which seems reasonable. This will give them 1.6 billion dollars of gross profit, even once they reach scale. They'll have to continue spending a significant portion of their gross margin to research and development, sales and marketing and general administrative expenses.

We assume 50 of gross profit falls to the bottom line as net profit. This will give them 830 million dollars of net profit. By this point, toast will already be at scale and they won't have that much growth ahead of them. Therefore, a 20 times price of earnings multiple seems reasonable.

This will give them a 16 billion dollar market cap. Remember that their current market cap is 28 billion dollars, which is almost 75 higher than our optimistic scenario where they take 50 market share. This doesn't even take into consideration the time value of money, as will take them many years to reach scale. So obviously, the market is pricing in a much more optimistic scenario than our projections to see.

If there's any way to justify the current valuation, we re-ran the numbers being even more optimistic. We assume their revenue per restaurant can increase to 35 000. This might be possible if they roll out new software solutions which can increase subscription revenues. We also assume that they can take 60 market share.

These are extremely optimistic assumptions. This would give them 7.3 billion dollars of revenue. We also assume their gross margins increase to 40, which is theoretically possible if they can increase their mix of subscription revenue. We assume operating expenses will only be 40 of gross profit and finally, we give them a 25 times price to earnings ratio which is pretty high for a company which is already saturating 60 of the market.

The assumptions we use in this scenario are extremely optimistic. Almost to the point of absurdity, but even still it only yields 29.4 billion dollars of market cap. This is only slightly higher than the current market cap of 28 billion dollars, and even this extremely optimistic scenario, it'll take them many years to get to that point. If you consider the time value of money, the investment would still be a loser based on the fundamental.

There does not appear to be any way to justify the current valuation. In our opinion, there's a difference between a good company and a good stock. Toast is clearly a good company. They have differentiated technology and strong growth potential, but no matter how good a company is.

There comes a point when the stock price is too high to be justified. There's no such thing as a company. That's so good! That stock is a buy at any price in the case of toast, they only operate in the u.s and focus on independent restaurants. The size of their total addressable market simply isn't big enough to justify a 28 billion dollar market cap.

Alright guys that wraps it up for this video, what do you think about toast? Do you think his valuation can ever be justified? Let us know in the comments section below, as always. Thank you so much for watching and we'll see in the next one wall. Street millennial signing.