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- [00:00]
Drew
Foreign.
- [00:06]
Alex
Welcome to the Synopsys, a Speedwell Research podcast, a podcast for professional investors all about investing. Or unprofessional investors, if you like investing. You're in the right place. It's been a while since we've done a company episode, which is a deep dive on one of the Speedwell Research reports. These are usually 80 to 100 page reports. Speedwell Research has spent an immense amount of time, energy, and resources writing essentially a primer on the company, the industry, the competition, evaluation, everything you need to know about it. We've been doing this now for a couple of years, so we have a lot of these company episodes. It's just been a while. Because, candidly, your host gets lazy. They take a lot of time and research it. You know, we've been doing some more short form dialogues. And then one other thing. Speaking of your lazy host, Drew is also releasing a monologue out here. So when I am unavailable, the Speedwell listeners do not have to go without Drew's voice. They can continue to listening to him. Is that right, Drew?
- [00:59]
Drew
Yeah, you. You probably already saw that in the episode catalog now, but that is going to be a new format we have for when our host is, quote unquote, stuck behind a golf cart in traffic. That is actually what he told me, why he was late today. I don't know what that's a euphemism for, but there's this.
- [01:16]
Alex
I was 30 minutes late. The golf cart delayed me maybe 25 seconds of those 30 minutes, but nonetheless, there was a golf cart on the road going three miles an hour. It wouldn't let me paste, and I don't honk because I'm too passive aggressive, so I just sat behind it.
- [01:31]
Drew
But anyway, so we're gonna have these different episode formats. The company episodes go to our backlog. All those are evergreen. They're still relevant. The dialogues, those are gonna be me and Alex talking about different business topics. There'll be updates, sometimes from the Speedwell companies. Sometimes it'll be us talking more about a business we covered on the YouTube or the newsletter. Then we'll have the monologues. That'll mostly be updates, just to keep those kind of timely and, and get those out quickly. And then we'll have interviews as well. That'll be the fourth one. And I mentioned kind of this previously, we got a lot of new interviews coming up. One of them is actually going to be none other than Shift4's CEO, and I think also the CFO will join the call as well. And so that will be Coming out probably in March. I'm going to go ahead and record that. So this is going to be your episode on Everything Shift 4. You'll have plenty of time to digest it and just know that that is coming out. So also feel free to drop any questions, questions you might want me to ask in the comments on Spotify or on Twitter.
- [02:24]
Alex
Yeah, pretty exciting, you know, little CEO CFO interview. We'll see where it shakes out, but that'll be cool. I think they'll be much more knowledgeable about the company than myself. So this will be a good primer for Drew to then dive deep into those analysis questions with the leadership themselves.
- [02:38]
Drew
I just, I'd like to note the host's humility that he is two hours reading the port. He decides that he knows less than the CEO of the company. That that takes a lot of humility to admit that, you know, I have
- [02:50]
Alex
a lot of good qualities and humility is one of them. I know marginally less than the CEO of this company. So you're right. It's true. I'm going to do my best here. So before we get into it, what is Shift four? I don't think it's a household name by any stretch of the imagination. And I don't even know maybe why you even picked about why you even were interested in researching it as well. We can talk about that.
- [03:09]
Drew
Yeah. So I guess two things. One, I've always kind of wanted to dive more into the payments industry. And then it's just kind of a question of like what business business to pick. And Shift four stood out because it's very obviously hard to understand if you just spend like, you know, two minutes looking at it. There's a lot of different aspects of the business. Shift for itself was not actually the original business. The original business was United Bank Card. And they've gone through multiple acquisitions and business transformations, all of which we're going to get to in the history and it's important to understand. But it was kind of a mix of that it sold off a pretty good amount, you know, 51% so far as of this recording. Right now it's at $59 a share. It's also, at least very recently, was founder led. But Jarek Eisenman, who has started the company as, you know, a teenager basically in high school, and it's been running the company until a couple of years ago, he still has a good ownership share, but he stepped down to become the NASA administrator. And so all those kind of factors of, you know, founder led kind of Misunderstood, big sell off. But generally speaking, you know, payments are, you know, they can be commoditized in a way, but you're finding these certain sort of businesses within the value chain that could be, you know, pretty strong franchises. And so it just kind of was an interesting opportunity and just, you know, also how much it sold off and all that. So I felt like it could be an interesting one to learn about. And I was right. It was very interesting to learn about. And so we're going to teach you all about the business here today. And just some numbers. You know, it's a five and a half billion dollar market cap. They do have a good amount of debt. So it's a $9 billion EV right now in my numbers, it's trading on trailing about 17 and a half times free cash flow or about 3 and a half times gross profit. So, you know, the valuation's really not that demanding. And then it's also been growing, you know, it's pretty acquisitive, so, you know, an asterisk on some of this growth. But we're going to talk a lot about their acqu led growth, but growing, you know, low 20%. Maybe it's going to accelerate a little bit closer to 30% with this last kind of acquisition of Global Blue. So a lot to unpack there. But it's a payments company and we're going to get all into that. Yeah.
- [05:03]
Alex
And again, payments companies, it's just something that I feel like I have learned and relearned multiple times. You know, you want to go look at a visa or a MasterCard and you spend a lot of time understanding the history of the card networks and how do they make money and how does this interact with the merchants. And you know, then there was kind of the fintech revolution at the end of COVID where you had all these fintech companies who were going to say we're going to disrupt, you know, Visa and MasterCard, and how are they going to do that? And let me tell you, if you don't look at this stuff a lot, you can learn it and relearn it. And it's just a lot of vocabulary, a lot of esoteric facts and a lot of nuance. And so I think before we're going to kind of do things out of order here where I want to get kind of into the payments industry. And again, you could do. We're trying to keep a shorter podcast these days, so I don't want to do a full four hour industry dive here. And I'm sure, I think Acquired has a pretty good history of Visa, which I think you can listen to, but in terms of just the nuts and bolts.
- [05:51]
Drew
Thanks. Now you just left.
- [05:55]
Alex
Yeah, there you go. Listen, I'm all about resources, okay? You guys can listen. It's a. They've got a. They've got more than enough information. Anything you want to know about Visa for the last 40 years. So, yeah, I just want to do a quick high level overview of the industry and kind of, you know, what are the terminology? What's the basic terminology? Guardrails. Who are the players here? And then we can actually get into the business history of shift 4 and where they fit into this mix. But, Drew, I'm going to let you take it away. Explain how payments work in the U.S. you know, you got five minutes.
- [06:23]
Drew
Yeah. So I'm going to just kind of give a little bit of an overview and this is kind of how I organize it and think about it. So there's obviously a lot of different players involved from the moment you swipe your card to the money actually moving. Right now, there's kind of these two big aspects, subcategories within payments. We could call it where there's the payment processor and then the merchant acquirer. Now it gets complicated because a lot of times companies will do both. They'll do half of both. They'll call them different things, like a payment facilitator and all sorts of different things. But let's just simplify here. There's a payment processor that is the one who processes the data involved in the payment and then sends the data on how the money needs to move. So it's not always necessarily the person actually moving the money, which is why it gets a little confusing. But the payment processor is the one who processes all the data involved in that payment and figures out how the money needs to move, and then it'll send that request out. They do that all the time. Now, the merchant acquirer, that is going to be the entity that holds the contract with the merchant and takes financial risk should a fraudulent or erroneous payment occur. And so, yes, many companies do both, but that is strictly speaking what a merchant acquirer is and what a payment processor is. Now it gets confusing because the merchant acquirer will kind of effectively front the money to the merchant before the settlement of the funds. And so they'll do that to help give them the money sooner, but they're not actually really moving the money involved in the payment. It's kind of like their own money they're fronting to the merchant. And so that's why you could see money move, even though they're not technically a part of that, like backend settlement of the money. So Shift four, for example, is a merchant acquirer, but then they're also payment processor. And so they do both of them.
- [08:17]
Alex
They.
- [08:17]
Drew
There's not a lot of entities, at least currently, that, you know, people know about, like new fintech names that only are merchant acquirers and don't also do the payment processing. Because if you are holding a contract with the merchant and taking the financial risk, then, you know, why wouldn't you also want to do the payment processing, which is where the profit center kind of is. And so there are merchant acquirers that are like kind of these lesser known, you know, sales forces basically that'll go out and do this and we'll touch on this in the history too, and so that'll become a little clearer. But most of kind of like the fintechs that you know of aren't just strictly speaking a merchant acquirer. They'll also do, you know, the payment processing. So that's kind of the one angle. Let's hit it from a different angle now, where there's authorization, and settlement authorization starts when the customer swipes their card or they're entering their payment details on the webpage. Then the information is going to be captured by something called a gateway. Remember this name? It's going to become important in a moment. So the information is captured by the gateway, it becomes encrypted. The data is then forwarded to a payment processor. The payment processor then receives the request, forwards it to a card network like Visa or MasterCard. The card network reaches the customer's bank, which we're going to call an issuing bank, and then the issuing bank sends back the approval decline that you see on the thing. So that's confusing. That'll get clear when we talk through the history and all that. This is just to build a little familiarity and it'll become clearer later on. I just want to point out again, though, that one comment I made about the gateway, that is the part that just captures kind of the data on the credit card terminal or on the web page and then encrypts it and forwards it along. I'm calling that out because right now, gateway payment processing, they're usually kind of one of the same people don't separate these out. But for legacy reasons, this used to be a separate sort of entity that does that. I'm pointing that out now because shift four is going to do something where they actually acquire A lot of these gateways and then push, push them onto their payment processing. So now you can understand what gateway is. Now the other kind of aspect, after authorization comes settlement. So on settlement, the processor, the payment processor is going to bundle all the merchants transactions and sends out the data. And then a request for the funds is sent to the various issuing banks through the card Networks through Visa, MasterCard. Then the issuing bank transfers the funds to the acquirer's bank through the networks as kind of a clearinghouse. And so that is kind of those two aspects right there. Most acquirers actually outsource the moving the money to these legacy processors like Pfizer First Data and worldpay. Adn, for example, is a notable exception to that. They're a fully integrated stack. But even shift forward, this is usually one element of the transaction they're not doing, which is the actual backend, what is called the back end settlement of the funds, when the funds are actually moving around from the banks that people still use Pfizer First Data and worldpay for that. So that's a little bit of an overview right now. Some aspects, again, if any of this is confusing now, we'll get clear when
- [11:18]
Alex
we're actually going super easy. I'm following it. I don't know who wouldn't be.
- [11:24]
Drew
What are your questions?
- [11:26]
Alex
No, no, I, I know. I think it's, again, it does make sense. You just. It's a lot of vocabulary that I think someone has to keep straight. I think again, 1. And as we talk about it, I do think it'll be clearer. But I think that one kind of exercise that could be fun to do right now is just, okay, so I walk into a store and I put my credit card down and I pay for something, $100. And we'll just say that, for example, for the sake of it obviously usually a merchant discount rate, which is essentially the fee that kind of gets segregated out across all these players to make this, you know, kind of magic work of the credit card system. So I go pay $100 to a merchant. A merchant's gonna have a terminal. Okay, now we're talking about some other stuff, but they have a way to accept those credit cards and then they're going to get essentially 98, you know, somewhere between 98 to $97 in their bank account, depending on what happens. Take us through where those $253 go and like, who are kind of the players in the stack as you just kind of described it? Yeah, I think that's also a helpful way to Think about it as well economically, just following the money through the chain.
- [12:26]
Drew
Yeah, I think that's good. So this is going to be $100 transaction. This is going to be a credit card transaction we're doing, by the way, because on debit cards, everything changes. It's much less. There's, there's no fees. I'll caveat that in a second. But this can be a credit card transaction. So let's say that the average fee here is going to be 2.75% or 275 basis points. So that is going to be the merchant discount rate. Now to rewind for a second look on your credit card right now, you know that there's a name of a credit card, but then you'll also see a bank name on it. That is going to be the issuing bank. That is the person who actually is taking credit risk on this transaction for you. This isn't the merchant. Don't confuse it with the merchant size. This is going to be the consumers issuing bank. So real quick, let's say, you know, you pull out a Citi credit card or JP Morgan credit card. You'll see in the corner there MasterCard or Visa, that is the card network. Whereas JP Morgan or Citi are going to be the issuing bank now maybe of American Express. And you're saying, oh, there's no bank there. American Express is the bank in that case. Actually, they're both.
- [13:31]
Alex
And this is where it's fun because, you know, you start throwing around these terms and then some of them, they do a lot of them and then other ones don't do others. And then. So, you know, I think that's why it gets a lot of confusing, because some do more of the chain than others. But again, I like it. You're keeping it simple. So let's say a J.P. morgan card issued by Visa. There you go.
- [13:48]
Drew
Yeah, I'm glad you're having fun over there. That's good. So the merchant discount rate on this transaction is going to be 2.75%. That is going to now be split into basically three parties. We're going to have the interchange, which is going to go to the issuing bank. So the issuing bank makes money on this transaction, right, because it's their credit card, they get a big chunk of change and they actually get the most kind of economics of everyone in. Part of that's also legacy reasons because they end up rebating a lot of that back to the consumer in the form of credit card rewards. So on this 2.75% transaction, let's say the interchange is 1.95%. So almost 2% of it is going to be an interchange.
- [14:28]
Alex
And you know, obviously that 1.95%. And again, as a percentage. Right, the lion's share here. But those are kind of used as credit card rewards. And then, I mean, those are kind of also offsetting the credit risk. Obviously, you have interest rates as well. But again, does that kind of help offset the credit risk, or is that mainly for profit and redistribution of rewards back to the consumer?
- [14:48]
Drew
Yeah, how do banks think about that? The credit risk should be thought of separately is being tied more to the interest rate charged on the credit card, because the more credit risk you are, the higher the credit card interest rate is going to be. And then they all could have other fees kind of layered in there as well sometimes, you know, missing payments and stuff like that. But the interchange is more just kind of like a core fee. Regardless of how, you know, you could be, no credit risk, really, they still need to make money on the transaction and then fund the rewards. And so that's how they do it. So that's the first one that's going to be interchange. That's going to be 1.95% of this. The next one is going to be what's called assessment. This is the network fees. This is what you Pay Visa and MasterCard. This is going to be about 15 basis points. So it's a small piece of this transaction. People also, though, you know, kind of a little resentful of this piece of the transaction because they're not taking credit card risks. They know Visa and MasterCard have really good margins, but, you know, you can't really squeeze them because of the network effects of all this.
- [15:45]
Alex
And again, that's why Visa and Master, everyone loves those businesses and we're trying to disrupt because they're so entrenched into this that they are really the connective tissue between all of us. And it's very, very hard to unseat them from this. But again, that's a different podcast. So, okay, 15 basis points goes to the card networks. And then we get to kind of where we're spending most of our time here on the payment processor markup.
- [16:05]
Drew
That's right. And so this is going to be that last piece of the merchant discount rate. We're going to call it about 65 basis points in this example. That is going to be what the payment processor gets to keep on this transaction. So Once again, a 2.75% merchant discount rate, 1.95% goes to interchange, which is the issuing bank. 15 basis points goes to Assessment, which is the networks, Visa, MasterCard. 65 basis point is going as this kind of payment processor markup. Now, there's other ways you could cut this and all that. Let's just keep this simple. And I think that makes sense and it's going to be helpful as we go through the history and all that. Again, if you're a little lost, I think things will clarify as we keep talking more about this business.
- [16:45]
Alex
And then, you know, one thing you mentioned, as we were kind of talking about some other things, you mentioned the Gateway, which is kind of this data encryption and then actual the processing and what that actually means is that all embedded into that 65 basis points in that processing.
- [16:56]
Drew
Yes, it is. And that's a good question because historically Gateway would charge a couple basis points and a few pennies, like 5 cents per transaction. But Gateway is actually technically a very complicated aspect of all of the payment processing. And the payment processing itself is actually a little more commoditized. So it was this weird situation where in the value chain, the thing that was actually creating a lot of value wasn't monetizing proportionately to the value it was creating. And so again, that's because it was just taking a couple bips, whereas the payment processing was taking, you know, 60 plus. And so one of the things Shift4 did was they went after these gateways and they attached it to the payment processing. And since gateway is actually a more valuable sort of service, harder to rip out and the payment processing is commoditized, kind of combining those two was actually a good business move. And we'll talk more about that there. We're getting ahead of ourselves, but that's kind of the landscape.
- [17:53]
Alex
Okay, so I think we have some foundation here and we'll keep fleshing it out. And I think throughout we're going to be a little repetitive and I think defining vocabulary. So we don't, we don't lose anyone here. And by anyone, I mean me. So let's get into the history of shift 4 and let's do a little high level overview. I mean, again, Speedwell, very thorough. We start with the foundation and Jared Isaacman, the founder of Shift4, starting the company, dropping out of high school in 1998. But why don't you just take us through really quickly those early days. Again, a pretty interesting founder and CEO. He was also later appointed to NASA and they kind of caught up in the Elon controversy of, you know, Trump and Elon's friendship he was kicked out of NASA, brought back to NASA, but that's later in his life. What is Jared doing in high school?
- [18:34]
Drew
Yeah, so he was a high school dropout. Basically the deal with the mom was if he could pass his GED and take some college level placement tests, then he could drop out of high school. And so he was able to do that. And then he starts working at Merchant Services International where he starts learning about the payment industry and pretty quickly figures out that there's a business here. And, you know, as a kid he was pretty precocious, great on computers. He had an earlier business where he actually worked at Comp USA where he handed out his personal business card to customers to help them with computer help and then also designing websites and stuff like that. So he was already kind of entrepreneurial. He saw this other business, decided to go after the payments opportunity, borrowed 10 grand from his grandfather and was able to get a bank identification number which allowed him to sell credit card terminals. And then he gave this new company the name United Bank Card and went into business. In the late 90s, the value prop was simple. Eliminate the hassle a merchant has to go through to accept a credit card. So most credit card companies, they cater to enterprise businesses and smaller merchants were kind of an afterthought. Just kind of one thing he talked about. This is from a 2015 interview he had. He said, you know, a pizza joint to open up a credit card account. There was as much paperwork as signing up for a mortgage. And the sheer amount of inefficiency in the industry was ridiculous. There was no innovation, no streamlining. Nothing was being directed towards improving the merchant's experience. And so, in short, United Bank Card reduced the amount of paperwork to just two pages instead of the industry standard, 30 pages, and was able to approve people within a day. So that was basically the value prop of the service. Let's get a lot more people accepting credit cards. As you can imagine, that's a pretty good revenue enabler for a small business. Accepting credit cards now kind of key to their success. And I'm glad we did a little bit of payment overview because now we can slip this in and maybe it'll make more sense. It traces back to kind of how the industry was started and it's going to lead to basically this kind of growth hack that they were able to take advantage of. So you go back to 1958, bank of America rolls out the BankAmericard. This was initially a fully integrated service where they would handle everything from signing up the merchants and issuing Cards to prevent fraud as well as processing transactions. So they created the credit card basically, and they did everything initially. And you know, competitor in 1966 came up called Interbank Card Association. So now you have a competitor credit card company coming up too. And so what ends up happening is as technology gets better and better and the need to grow more and more and to prevent fraud, and it just becomes very operationally hard. And banks really realize that they're not that well equipped to deal with all of these different kind of technological issues, operational issues, salesforce issues. And so they basically wanted out of that game. And they only wanted to be. Now what we kind of know as the issuer, the one who is issuing the credit card and is responsible for managing and taking account for the credit card risk and making interest off of it, but not actually all the other aspects in the credit card sort of network. And so they end up spinning these two associations off. One of them becomes a Visa, the other one becomes MasterCard, basically. And so now you have these card networks there. And the other sort of elements in the industry also end up modularizing. And so now that you have these card networks and you have a bunch of issuers that can now connect to the card networks, there's this new sort of job of merchant acquirer that comes in that is going to go and try to sign up all of these different merchants. And so this is going to connect the merchants to the actual card network so consumers have a place to spend money. And as a reminder, the merchant acquirer, that's going to be the one who actually creates the contract with the merchant. And very often too, they're going to also be a salesforce kind of signing them up for a payment processor, a card terminal, all the hardware kind of involved in that. It doesn't necessarily need to be the integrated. I mean, now it is kind of integrated because that's the business, but that back then it really wasn't. And so the way this kind of worked too was then there were these new kind of businesses that popped up to help grow the merchant acquirers business. One of them was called an ISO or an independent sales organization. And so now the value chain fragments even further. And these independent sales organizations go ahead and try to sign up merchants on their behalf. And they're basically an outsourced salesforce. And so they usually work on commissions. If we can go and get a bunch of people signed up, I get a percentage of either their payment revenue or I get a commission on the sale. However we want to work out that deal they're agnostic to whose ever product they're selling. They just want to sell a product. And so they're kind of, you know, you could think of them as a car salesman who has a bunch of different cars to sell. And they don't actually care what car to sell you. They just want to sell you a car. That's kind of how it works for them. They just want to sell you one of the products, get you signed up. And as long as they do, they'll get their commission. And so if a product is a lot easier to sell, they're going to lean into that product.
- [23:23]
Alex
So these again, to kind of recap here, these are salesmen. They're selling essentially a suite of credit cards that are hosted by merchant banks.
- [23:31]
Drew
No, they're not. They're giving merchants basically the ability to accept credit card payments. So they'll be giving them a credit card terminal, maybe later on, you know, a POS terminal, some sort of hardware to accept credit card payments as well as then link them up with a merchant acquirer to actually have the contract with them to accept credit card payments, have them basically be on the hook, connect them to a payment processor downstream of that as well. So they're enabling merchants to be able to accept credit card payments.
- [24:01]
Alex
And at this time, the payment processors, they are sitting in between the merchant and the bank, right? Or like where are they sitting? Yes. Okay, so the ISOs, they're going into merchants, they're trying to get them terminals, they're setting up the processing ability, they're taking their processing fee and they're trying to sign up or again, whatever bank. Is there a process in which a bank is caring about what's happening here? You know, are banks incentivizing anyone to, okay, you sign up with my U.S. you know, I want this merchant to use payment processing to bank of America.
- [24:32]
Drew
So there, there's consumer banks, right? And then there's also banks that specialize on the business side, you know, the, the merchant bank. So they're not usually always the same. You know, JP Morgan Chase does have a big, you know, business banking to small businesses, small merchants. So in that case, yes, they, you know, do have ISOs, these independent salesforce organizations going out to sign up merchants to become, you know, their bank partner of choice. And that's on the other side of the transaction. So it gets confusing because you again, have these players doing multiple different sides of the value chain, a lot of the same names showing up. JP Morgan to attract people onto their credit cards. On the consumer side you know, they'll, they'll mail out a bunch of, you know, credit cards to people. Now that's illegal, but back then that's what they used to do. Now they'll just mail you a picture of the credit card and say if you sign up, we'll give you a real one. However it is they get you on board, that's on the consumer side. They're pretty good at advertising to consumers because they're ultimately a consumer facing business. Now not all banks though have this same sort of business aspect or the merchant aspect. And so that's why they're relying more on these independent sales forces to go out and find these merchants in the first place, sign them up, give them a contract, become a client of theirs. And so that's, that's kind of how it works. It gets confusing though, because a lot of times a payment processor will also be a merchant acquirer at the same time in order to get business or for their payment processing business. And so that's why it gets a little confusing. JP Morgan Chase, for example, they have their own payment processing business too. Now we're getting even more confusing. But you're right in saying that there's the merchant, there's the ISO, there's a merchant acquirer. Sometimes those overlap. There's the payment processor, sometimes those overlap. And then there's the card networks, those are totally separated out. Then there's the bank, sometimes those also overlap. And then there's the consumer side at the other end of that. Does that kind of at this point.
- [26:23]
Alex
And again, we're talking about the early days of shiftforce. So at this point the individual paying the ISO. So again, ISO, you're spinning up this, you know, kind of salesforce. They're going door to door, they're knocking on diners. Let me set you up with a payment processor. And when they close. And again, you have at this time several payment processing companies that are either associated or not associated with the bank.
- [26:44]
Drew
Mostly not. Yeah.
- [26:45]
Alex
So payment processors that are not associated with the bank. Okay. And the salesforce is essentially this independent salesforce is being paid off by the payment processors.
- [26:58]
Drew
It depends. So there could be some contracts where you could get like a residual payment stream based off of how much payment processing volume the merchant does. And we'll talk later about that because shift 4 actually bought people out of those contracts. So in that case they're kind of indirectly paid by the payment processor. In other cases it could just be an upfront commission. And so the merchant acquirer, just remember, is the one who just is holding the contract where the payment processing is actually moving the data around. And so these players are very often the same now though. So whether or not you want to make that distinction, maybe it's just not helpful at this point.
- [27:35]
Alex
And then who are the big payment processors at this time? Because again, Shift four obviously gets into this business later. But who are they right now? They're kind of working for the payment processors.
- [27:44]
Drew
Yeah. So there's a bunch of different mergers and name changes over the years. They're basically the legacy companies that become, you know, first Data worldpay. So those, those companies Pfizer. So those companies have that kind of payment processing business. Those, you know, you could seed back to like the historical versions of that where they just did that. Now I mentioned though, you know, some of the banks did still do the payment processing too. So it gets a little confusing. JP Morgan is one that still does it. So that's just kind of though setting the stage and why this gets so confusing. But I promise you we keep going, it'll get clearer.
- [28:20]
Alex
Okay, so we've clarified some things. Maybe people are already following it better than me, but I enjoy the re clarifying. I've read the report, I've looked at payment companies. I need a lot of re explanation of the terms here because it does get a little jumbled in my brain.
- [28:32]
Drew
But yeah, to be fair, I mean like I wrote the report and I needed to go through it again to just make sure I got it all right.
- [28:39]
Alex
So got it all straight to re explain it. So thank you. You know, I appreciate the host is being overly humble today. Like I said, I know less than the CEO of the company. I can confidently say that. So we are okay, moving on in the history. So right now they're in ISO, they're working for these larger payment processors.
- [28:55]
Drew
Yeah. So the reason why we did all this and we did that big loop to explain this was to say that the reason why they're able to go so quickly is because these isos existed this independent salesforce and they only care about selling the best, easiest product to sell. And Jarek Eisenman with United Bank Card just created the best, easiest product to sell that only has a two page contract and can get you started in a day. So these ISOs grab that product and just sell the crap out of it. And so it doesn't matter that he's, you know, some 17, 18 year old kid right now. He is becoming, you know, one of this industry's very big kind of players very quickly as a result of this. And so, you know, they're onboarding 2800 merchants a month in just two years time after starting. And this is a time when, you know, credit cards weren't that common back then. And so that is, you know, pretty good growth that they're having at a time. And then a big inflection point came in 2000. So at the time, industry incumbents were leasing credit card terminals for 60 to $100 a month. And Jared Isaacman made the contrarian decision to give them away for free. So subsidizing the hardware in exchange for longer term payment processing relationships. And so essentially it offered the merchants free credit card terminals, check readers, signature capture devices with the merchant account. And then in exchange for that, we're going to do a longer contract. And so they're now acting as the merchant acquirer, in this case with the, the contract. And I'm pretty sure by then they also were the payment processor of the, of those transactions as well. And so that is kind of how they were monetizing that.
- [30:23]
Alex
And so again, if you were to summarize their early competitive advantages, it's one, the efficiency of their ability to sign up a merchant. You know, they're not doing that, just kind of copying and pasting traditional loan methods. Right. That, that whole process to essentially get a, you're doing a term loan with a bank. I mean, it's like getting a IRS audit. They're going to pull everything and have all this information shortened significantly. And then secondly starting to give away and bundle the hardware with a longer service contract. So, yeah, those are the kind of two main competitive advantages they have. Okay, Drew, continue how Shift 4, continue to run with this as they kind of redefine some of these marketplace moves, which of course are quickly copied as well.
- [31:00]
Drew
So, yeah, I mean, so right now we're like getting in 2008, like payment processing, the ability to accept a payment and process it is becoming more commoditized. It'll become even more commoditized in the future, but it's now not the best competitive vector to win on. And so they start moving more into point of sale. They launch something called Harbor Touch for small restaurants and retailers. And now point of sale just kind of the difference here is that when you're doing payment processing, let's say you do a transaction for a hamburger for, you know, $9. You know, this is 2008, after all. So, you know, you sell this hamburger for $9, and that is all that shows up on the credit card transaction you get. You Know a name, the credit card number and what the dollar amount is on the pos it'll capture. Oh, this was, you know, table 117. This hamburger was medium, extra cheese. He asked for no pickles and extra sauce and then also, you know, whatever else. And so all of that shows up on the POS that can then coordinate with the kitchen to send out the orders on time. That can also coordinate with, you know, any accounting software they have that can coordinate with inventory management. Oh, you know, we're selling X number of hamburgers a blah, blah, blah. So it's, it's really an important aspect of the entire business to track the sales, manage the inventory, generate the reports and all of that. So they're moving more into the POS because that is a stickier sort of service. And once you're also able to get that, it's harder to rip out. So if you have POS plus you're doing the payment processing, then that's together a better service. You're tying them together. So you don't necessarily monetize the PoS directly though. You monetize the payment processing, which has been the key to kind of shift forward this entire time. They're monetizing the payment processing and they'll kind of win the business with these other aspects like in this case, the pos. And so Harbor Touch rolls out. That's their first sort of edition of this. And it took several years to to gain momentum, but you know, they're seeing more and more success here. And he decides to rebrand the business from United Bank Card to harbor touch in 2012, signalizing kind of the evolution from payment processor to vertically integrated software and payment platform. And so in 2021, he talked about what Harbor Touch was. This is a quote from the investor day and quote, we pulled together multiple industries together from restaurant Point of Sale hardware, and we bundled it together with an integrated payment solution. Then we put a SAS bow on top of it and armed distribution partners with it to go out and win. That is still an element of our business that's growing very fast. If it sounds like toast or a revel or clover or square, it is. And we're doing that in 2008, before people were considering those strategies. And so to continue to develop and improve the POS product, they launched a new one. They called it Lighthouse. This one synchronizes all local data and now is a cloud based portal too. And so that's kind of the next iteration of that. One of the most interesting aspects of this business and Something that also is kind of curious if you think about it, because Shift four or you know, United Bank Card started In, you know, 1999, so many years before a lot of these other fintechs that would come up later on stripe and square. Yet it was a lot smaller, right in terms of market cap. And you know, even revenue and earnings took a long time for them to even, you know, join the billion dollar club. And so it's kind of a question of why that is. And the answer is they never took outside money during their entire early history during the tech bubble and all that. They never took any outside cash and were entirely self funded. So part of the self funding was because the ISO arrangement, they never had to invest that much for growth because the kind of investment and growth was basically just commission off of after sales were already done. But there still were other things that they theoretically could have invested in. So not until 2016 do they take a half a billion dollar investment. And this is now a private equity investment and they're doing 10 billion in annual card volume at the time. And they start looking for kind of other ideas of how to better differentiate their Service. And in 2018 they come up with this new idea of going after Gateway. So now you know what that is because we talked about it earlier on. So they're going after this Gateway node in the value network and they start by buying a company called Shift4 in 2018. So that's going to be this next chapter of the business. Honestly, the everything before this, it matters a little bit, but not as much as what happens afterwards because that's going to really characterize what the business is today.
- [35:24]
Alex
And real quick you we're going to start seeing this strategy in which pretty much everything is served towards getting. Again, a lot of the strategy is about getting volume through their payment processor. And I know we haven't talked about the economics a little bit, but again, how good is the payment processing business? High level. Like you know, we talked about the, they're making 65 bips of that 2.75 transaction. Like what is that? Is that really an attractive high margin business? Maybe you can just give the listeners a little bit about why they're so focused on it.
- [35:52]
Drew
You know, the good parts about this are that payment volume, you know, tends to go up over time. Your revenues are tied to how much money the business is making and is every time they make a transaction you make some money, you're getting those, you know, 65 or so BIPs. And your question though, on whether or not it is a great business. It's not really, which is why a lot of the other players did the opposite of what shift 4 did. Shift 4 is trying to monetize payment processing and gives away later on, you know, software, but then also, you know, gives away hardware. Whereas competitors are doing the opposite. They want to give away payment processing, drive that down as much as they can, not make that a profit center, and Instead monetize on SaaS. The kind of result of this, though, is that merchants do tend to be, while they are pretty price sensitive, they also don't love all these SaaS fees because those can, you know, end up being a lot more. And so it's kind of like they went after, like the lower margin opportunity. And because of that, like a de facto puts them in a better position. It's not a better business per se, you know, economically at least. But because other people are trying to monetize off a SaaS and they can undercut them on SaaS and instead monetize off of payment processing. It's a little bit of like that aspect of where Jeff Bezos is like, your margin is my opportunity, because overall they're kind of making just less money off of the individual merchant and other people are charging more. But it doesn't cost them anything to give software away for free or at least incrementally. And so. So that's kind of been their approach. But is it the best business in the world? No, not necessarily, because again, it's pretty competitive, kind of commoditized. And then you kind of do have to have these other aspects, whether it's pos, Gateway, a good software service, a platform, something else, to actually protect the payment processing revenue and be able to charge that in the first place. So it's kind of like a roundabout way of monetizing these other services. So it's not a bad business, though. I mean, it's pretty sticky once they have all these elements in place. And, you know, maybe we're getting ahead of ourselves, but, you know, there are, number two, play in restaurant, you know, 40% market share in hospitality, 80% in stadium. So some verticals can be even better businesses than others. But we could get to that later.
- [37:59]
Alex
Okay, well, I was trying to shoot how they were all trying to get into the payment processing, which is their high margin. And again, maybe in the grand scheme is as good or high margin of a business as Google. No, but it's, you know, that's their cash cow, the payment processing.
- [38:13]
Drew
Yeah, that's right.
- [38:14]
Alex
So they're trying to get more volume through their payment processing. And this is kind of with that in mind is why they're acquiring these gateway companies.
- [38:21]
Drew
Yeah. And I will say though that this is a really good strategy. Really good. Because you're buying Gateway. Gateway doesn't monetize that well and no one gives a crap about it. So you don't have to pay a big multiple for it. And then you take it. And before you were monetizing four to five bips on the payment. Now you're going to monetize, you know, 60 more bips on the transaction. So they do this kind of illustration where they're increasing the gross profit per transaction, you know, over four times by just converting that. And if you're on a legacy kind of system, you're going to, let's say you have the gateway. The gateway is not just tied to the payment processor, it's tied to your ERP system. And you know, they have, they talk about how they have over 550 integrations, sometimes even more so all these different integrations. So you're a very complex, let's say a hotel or restaurant like Cheesecake Factory, that's one of their customers. And you have, you know, the point of sale, the ERP system. You have all these different software integrations and you're not going to want to switch out your gateway, which is like in the middle of all of this. And so if someone comes to you and says, you know, do the payment processing with us because we bought this gateway, now you're going to have to do payment processing through us, otherwise we're going to not support the gateway anymore because it doesn't make sense for us to support this because it's very, you know, expensive to support all these software integrations and not monetize it. You know, you're going to say, okay, fine, I don't really care who does my payment processing as long as you're taking care of everything else.
- [39:40]
Alex
A little bit of a gun to the head type situation.
- [39:42]
Drew
A little bit. A little bit? Yeah, a little.
- [39:44]
Alex
But I mean, again it's, it's kind of, you know, we talk about the disadvantages, which is payment processing, again, it's kind of like just commoditized. It's who can be maybe a little cheaper. But if you're as cheap as the competitors and then you have the advantage of not, you know, doing something super disruptive, then it's kind of like a no brainer. And again, this was a pretty unique insight because Shift four really executed. There are other payment processors And Shift four really executed, I think early on the strategy of trying to buy as many gateways as they could in deploying this, which again they executed on. They came up with the idea and seemed to have done, you know, a good job with. Right. And that's kind of last several large acquisitions they've done.
- [40:19]
Drew
Yeah, and that's exactly right. So they, they kind of take the same sort of strategy into a couple of these other value nodes and anytime there's like pos, it's kind of a similar thing, a point of sale system. So they start buying a bunch of these point of sale systems. Pos itouch, restaurant manager, future POS they pay like 10 times EBITDA, but it's the same sort of deal where they then push them onto their payment processor because they're not going to support it anymore if it's a legacy one. Now we're going to talk later on because of kind of how this all came about. They are one of the most like flexible payment processors where they do integrate with all these different places in the value node. They just got to figure out how to like monetize you correctly. And so that's a difference versus some of the new fintech players where they're a unified platform and they can't work with all of these different sort of players. And so that is something worth kind of keeping in mind. We'll talk more about that later. But they do more of these acquisitions. They do more gateway acquisitions too to the extent there are like merchant link. And then later on they do end up rolling out their own sort of in house platform. They'll call it skytab. That is going to be their own kind of take to go against Toast, basically to go against Square. They'll describe themselves as going after the more complex sort of payments where Square is on the easiest, they're on the most complex. But SkyTab is kind of, you know, an SMB solution somewhere in the middle. We're going to do a whole competitive landscape breakdown later on. We're just going to kind of touch on some of this while we're still in history. And so that's what's happening now. In 2020, the IPO had a $1.4 billion valuation. So so honestly a little surprising. Like, you know, you've been at this 20 years and you're only barely a unicorn. But this is because of this long kind of journey here, not taking outside capital, being self funded. He was able, he just had to
- [41:58]
Alex
say they were an AI payments processing company and they would have been worth 50. Drew. They just didn't get it. They needed better branding.
- [42:04]
Drew
That. That's probably true. Although, you know, maybe. Maybe 2020 could have had more of an E commerce crypto angle, something like that.
- [42:11]
Alex
That's true. You're right. You're right. I was. You know, that would have. What? They should have been doing that now. They would have been early to the AI boom.
- [42:17]
Drew
Yeah, yeah. But something interesting is in the IPO, you know, they raised 345 million, but Jared funds 100 million of it with his own money because, you know, this is when the market's falling out. They still push the IPO through anyway. And so he puts 100 million of his own money back into the business. And now they're kind of going after these more complex enterprise businesses. That's kind of going to be their niche. They focus on a lot. So sports and entertainment venues is going to be a big one for them. They start getting wins, you know, first ones with Las Vegas Raiders, and then they kind of keep going from there. They end up buying this business called Venue Next, which is like POS specifically for stadiums, and it's doing really well. All these sports stadiums are kind of moving on to that. They acquired them for only $72 million, so kind of not that much money. And that with another acquisition of something called Appetizer, which was a competitor. Spot on. POS sports and entertainment, they'll end up consolidating this market. So now they have, like, 80% stadiums and venues, and they're. They're continuing to grow that a little bit more internationally. That's a big business for them. Through all these acquisitions and everything. Now they have a big spot in hospitality. All these hotel chains, you know, they use them, so they have, like, 40% market share there. And then with Skytab, kind of their, you know, SMB kind of platform that they're going after. Yes, Skytab is also what they'll call, you know, the venue business and all that. There's different iterations of it, but the unified platform of Skytap, that's what they're using also to go after these SMBs, the restaurants, kind of more toast competition in area. And that's, you know, a number two kind of player there. And so all of that is kind of going on. They're going on this other, you know, acquisition spree. They end up buying a European payments company that also has a bank called Finero, which allows them to do payments internationally because of one small difference with how international markets work. Where you have to do the back end payment processing, which you have to be a bank in order to do that. So they need a bank license to grow internationally. So they basically bought that. Then they also do, you know, an acquisition of the giving block, a fast growing platform for cryptocurrencies. They'll do another acquisition for nonprofits, a bunch of kind of other acquisitions that they do and they keep doing them every year. We're going to talk more about all these acquisitions, everything later on. But kind of the biggest one they end up doing just in the last year is a company called Global Blue, which was about a third of their market cap. They paid two and a half billion billion dollars for it. At the time the Stock sold off 20% on the announcement. It's continued to sell off since.
- [44:41]
Alex
And the market hates it.
- [44:43]
Drew
It kind of does, honestly. And we're going to talk more about this in the business section, this business, but it's a very different sort of business because it's tax free shopping. And it's the same idea though. You know, we kind of get in there, we get an angle with the merchant, we get our foot in the door and we'll be able to cross sell another services. But in this case it's a little bit, you know, more tenuous whether or not they're going to be able to do that cross sell. So that's, we'll talk more about that later on. But that is kind of setting the stage there. And then one last comment that at the end of 2024 Jared Isaacman ends up stepping down to become the NASA administrator. And so that's kind of, he's a little bit more out of the picture. The CEO is actually Taylor Lauber now who was brothers with the original co founder of Shift4, whose name is Brendan Lauber. We didn't say much about him, but it was Brendan Lauber and Jerk Eisenman that originally started this business back in 1999.
- [45:35]
Alex
And so a brief history. No, but you know, I like about that history is we covered a lot of what the business does as well. And again we've alluded throughout the discussion here how they make money, payment processing and then again the details of what that is in the value chain. But let's really get into their revenue mix here. So again, two revenue segments which we're very thankful for. Not a costar with 11 different ones in different buckets or something of that nature. It's pretty straightforward. 89% of the revenue comes from this payments based revenue segment. And then 11 is coming from subscription and other revenue. So why don't we talk first about this, 89. And again, and this is mainly just all payment processing related revenue, right?
- [46:14]
Drew
Yeah, that's right. So the way it works basically is that they're going to charge merchants usually a per transaction fee that could be, you know, 15 to 30 cents. And then they're also going to take a percentage of each transaction that's going to be, you know, 2.6 to 2.9%. And you remember earlier we were talking about kind of the fee breakdown and of that, you know, if we're calling it, you know, 2.9%, they're going to roughly only end up keeping 65 bips of that because they're going to be paying the rest out to interchange in the network. So the way this actually shows up on the P and L is they have this big line item called network fees. And that is part of the reason why their gross margins are a little bit lower because it's kind of a pass through cost. So they're collecting all this money, they pay it out to the networks, the networks, you know, pay it out to the respective banks for the interchange there. And so that is kind of the big portion of their revenues, as you mentioned, it is 89% of revenues are about three and a half billion dollars LTM. And so that's going to be their main source. They do have this other metric that they call basically gross revenues, less network fees. And so if you look at it on that basis though, then this revenue stream drops to 76% from that 89. Because again, a lot of it is kind of just this pass through cost. So it makes the software a little bit more important. So you should probably think about it more as 3/4 payment based revenue and 1/4 SaaS. And so we'll talk about that in a moment. But as we kind of, you know, were talking about before, they're all about trying to monetize the payment based revenue. And it's been a little bit of a shift to this model more recently of also emphasizing SaaS and these other subscription fees.
- [47:46]
Alex
Right. And again, you have a really great kind of breakdown from the shift for 10k where they're really defining each of these fees and how that kind of payment processing revenue segment is made up. One other thing, you know, we alluded to this, they made a big acquisition of this big of blue, I can't remember something blue. And it's the VAT where it's kind of the VAT business that kind of got lumped into that as well, which again was a, the largest acquisition they've done. So maybe take us through that business real quick.
- [48:12]
Drew
Something the Blue vat. Okay. Yeah, it's Global Blue and what they do is tax free shopping, which I didn't actually know about this business. It's actually an insane business the way it really works. And so let's say that you're in the EU and they have value added tax on everything you buy. And the idea is that if you're a tourist, you should get that value added tax refunded. The idea is to stoke tourism, but at the same time also, you know, you shouldn't be like funding the government and all that if you're a tourist. You know, different countries make different decisions on this, but that's kind of the idea behind it. And then it's also a bit of a discount so you end up spending more money there. And so let's say, you know, throwing some numbers around. This is most common amongst like high ticket purchase items. So let's say that you're buying a Louis vuitton bag for €3,000. Maybe 500 of that could be a VAT. So the VATs range anywhere in the year from 17 to 27%. So they could get up there for sure. So it's worth getting that refunded. And so let's say in this case The VAT is €500. Global Blue will only give the shopper back a portion of that VAT refund. They won't give them back the whole thing. It's usually 50 to 90% of it. They'll give it back and they're actually going to rebate a portion of that back to the merchant. And so, you know, throwing some numbers out here. In this example, let's say the shopper may get 60% of the VAT refund back. So they're getting €300 back. And then of that other €200 that's being kept, maybe 90% of it is going to go to Louis Vuitton because they're very big, it's a big customer, you're going to want to keep them. And so the merchant is actually keeping a good portion of the VAT refund, which is pretty interesting. And again, this varies a lot. So a lot of times it's closer to 50, 50 though. So of that €200 that's being kept, you know, half is going to Global Blue, half is going to whoever.
- [49:58]
Alex
Can I tell you, reading that I got very angry. I'm confused. Do you have to do that. Because if I'm saving €500 or whatever on the VAT, why is any of that going back to anybody?
- [50:08]
Drew
It's a good question. Convenience of it, basically in confusion. So in first, like, a lot of people don't know how much they're actually owed on the vat and the merchant is the one who's like, walking them through how to fill out the forms, what to do and all that. And you don't even know that you're not getting the full thing back. And so you could theoretically, you know, download other forms and just do it yourself. It's just more work that way. And so Global Blue is someone who does it all kind of for you and it's easier and they have a bunch of kiosks at the actual airport to help you.
- [50:38]
Alex
The take rate of that, though, is great. Crazy. It's like, what on. I mean. And again, I know some of it's remitted back to Louis Vuitton, right. Which again, is also feels a little
- [50:47]
Drew
not cool, which is why, by the way, the merchant is like, hey, you know, we'll use Global Blue because they're giving us money back. Right. So that's why the person who you're working with, the store clerk, is happy to walk you through that process and they're happy to sell it for you in a way. But, you know, the alternative is, you know, you're stuck with a form, you're, you know, going through the airport, the customs and all that, trying to figure out this stuff by yourself. And so it's just a little bit more of a streamlined process. They have an app and stuff like that. But this has been kind of like a contention on, you know, whether or not there are going to be these other, you know, businesses that pop up and give you all of the VAT back or the government does it. It just. It doesn't seem so likely, or it's been tried and it hasn't worked.
- [51:30]
Alex
And again, you know, we don't want to get too. I guess we can get a little bit in the Global Blue here real quick. And there was the risk that the UK kind of just went away with that. Right. And they just said, this doesn't make any sense. And so that was a loss for that business. Right.
- [51:42]
Drew
And I guess that they said, yeah, we're not refunding tourists, that. So if you're a tourist, you come to the UK and you buy, you know, that Louis Vuitton bag. No refund for you.
- [51:51]
Alex
No refund for you. Yeah. Again, this is kind of an interesting business. And real quick, since we're here, what is the direction they're going in here? The global blue. And again we're going to get into whether the market thinks it was a good idea, a bad idea and I know we touch on a little bit, but the idea here is you are going to then try to sell payment processing somehow through this business, I assume.
- [52:11]
Drew
Yeah, you got it. I mean, so I mean like I
- [52:14]
Alex
said, I know a little less than the CEO, not a lot less.
- [52:18]
Drew
So the everything kind of they do acquisition wise is all about getting their foothold and the beginnings of a merchant relationship and then kind of upselling cross selling from there. And so they have the tax free shopping. It's something you know, that's pretty hard to do. There's a bit of a network effect now you have all these merchants onboarded. So now you could go to these merchants and, and try to cross sell them on POS because we already have tax free shopping or you know, try to move into payment processing and all that after that. So the way they kind of characterize this opportunity though is they're just trying to get 10% of basically global blues customers converted over to, you know, payment processing. And if they could do that, they'll consider it a success. So there's kind of a good portion of business they don't really think is going to come over. We could talk a little bit about this more later on. Kind of like the revenue growth estimates and an opportunity going forward. But that's just kind of high level the context.
- [53:07]
Alex
And we digress because this was really about the, you know, kind of the revenue segments and we got into a whole big blue thing. So I'm hosting, I got sidetracked but it seemed like an interesting business to kind of seemed like a good time to flesh that out. And again, I never really get into the duty free shopping personally because I never quite understood it. And now that I get it, I'm definitely not doing it. But anyway, so let's get back into this. So what is that other section segment, the 11% here?
- [53:30]
Drew
So again if you are taking out kind of the network fees, that cogs item, that's a lot of the payments just being remitted to the networks then that is really more like it's like a quarter kind of a revenue. So it is a little bit more kind of meaningful. So now we're talking about the subscriptions and other revenues. And so all of this is going to be everything from fees they're taking from providing hardware to the merchants, including the POS systems, the card reader, the tablets, they usually lease these to the merchants. You know, we'll give you the sky tab for 2999amonth, that's $29. And if you want to add other devices, then you know, there's a little bit of an other charge on top of that. Generally speaking, they've given most of the software away for free, but there is still some software fees now that they will charge on. And they've also started adding some other fees because why not? They have a new annual program fee which is going to charge up to 250 per device, up to $1,000 per customer. And so that's just kind of another fee layered on if you just want to stay connected to the network. And so they actually have a big list of fees, you know, kind of within, this is more within payment based revenues. But in total I saw a total of 30 different fees. They have stuff like an account funding transaction fee, acquired processor, fixed charge, card scheme fee, chargeback fee, that's for refunds, credit fund transfer fee, declined authorization fee, et cetera. So there's a bunch of other fees.
- [54:52]
Alex
So the card scheme fee, pretty, pretty interesting there. And it's a good way to think about it. Right? Which is if you're actually kind of backing out and looking at this as a kind of a truer percentage of their business being 25%, it is pretty material. And one way to look at this is some people might say, oh well, this is very high margin revenue because you already have the hardware out or whatever. But to me this seems like more almost offsetting their sales and marketing expense because they're giving away a lot of this hardware for free and then trying to get payment processing. But that doesn't really show up in S and M. So this is really kind of more so offsetting what I would consider is as hardware expense. I don't think this is really like high margin revenue. Is that a fair way to think about it?
- [55:30]
Drew
It's kind of both. So yes, you're right. You should think about the hardware as basically being sales and marketing in a way. We're kind of not trying to make money off of the hardware itself. Yeah, we're just giving that away. Having said that, we do still have layered in that some other subscription fees that you know, are theoretically, you know, 100% margin. I mentioned this, you know, annual program fee they recently added on, which people weren't too thrilled about. But that's, you know, pure margin in a way. And so how Exactly. You want to attribute that. That's a question we can have. But yes, you're right. There's an element of the hardware going away that basically being a customer acquisition cost. You could think of that as S and M. The one other thing, just because we're kind of talking about margins and all that is, you know, gross margins have been kind of expanding a good amount. If you're, you know, looking at 2019 kind of before COVID it was 24% LTM, it's now 33%. Some of that has been kind of the gateway transition that we've been talking about. So that's on the payment based revenue side. But then some of it also has been also the subscription revenue growing. And so yes, you're right on that hardware element, but there's other kind of revenue embedded in that too. That is higher margin. And so that's the other kind of aspect of that too.
- [56:39]
Alex
Yeah, good point. And just I think it's a good time to kind of illustrate what I thought was a really helpful graph because we've spoken about how this gateway business has been somewhat commoditized and they're trying to move again, all of us to pat processing. And we've alluded about the kind of the margin profile payment processing. It's still not, I don't know what we would consider an amazing business. Right. It's not like that defensible of a business. But again there's I think a lot of. And we'll get into this in competitive section, but a lot of these things moats, what I would consider around it that does make payment processing hard to kind of, I think steal. But why don't we get into a little bit of this gateway economics. How bad was the gateway business compared to the payment processing business? And then what's kind of the Runway here, right?
- [57:21]
Drew
Yeah. So they do this nice conversion economics illustration. Before we even get into that though generally speaking the gateway was like a couple pennies per transaction and then also maybe a couple basis points, whereas the payment processing revenue as we mentioned before was 60. So if we're looking at this sort of gateway conversion economic illustration that they nicely laid out. And so we have million and a half dollars of card volume, 30,000 transactions. The average ticket value is going to be $50. And then they kind of show the uplift going from gross profit to end to end gross profit, which is basically if they're also doing the payment processing, that's what they're calling end to end volumes and so on. Just gateway alone. They do 30,000 transactions. You might see a dollar sign if you're looking at this. The intern who maybe made this one messed this one up. So wasn't it wasn't an IB banker
- [58:09]
Alex
who, oh, Drew would have slept outside if he made a mistake like that.
- [58:18]
Drew
I don't know about that. But $0.04 per transaction will get you the net revenue of about a thousand dollars on this. So there's no cogs associated with that because there's not that kind of pass through cost. So it's going to be gross profit of a thousand dollars on end to end gross profit. Though if you are now doing the full payment processing, you have volumes of one and a half million. As I mentioned, they're going to do 50 bips on that. That's going to give them seven and a half thousand dollars of what they're calling acquiring revenue. They're going to add on top of that SaaS revenue of $200 and then they're going to have the cogs associated with all that and it'll get you a gross profit of 4,300. So you're going from a thousand to 4,300 basically. So you know, four times uplift in gross profit. So that is part of what you're seeing show up when we're looking at those gross margins and increased from that 24 to the 33% I mentioned. And so it's, it's a really good like model, a very good strategic move they made. And it's kind of, you know, a captive customer that. So they're going to go along with it. They also not aren't really losing anything by doing that. And so it is like just a big win for shift four. But it's also kind of one time in nature. And then once you run through those gateway conversions, that's kind of it. And so they still have a little bit more of that volume left. They used to talk more about how much of that conversion they had left to move to end to end. That's been less kind of emphasized as that opportunity has kind of been gone after a little bit more aggressively in the past few years.
- [59:38]
Alex
Right. And as that opportunity is manifesting, you are seeing this materialize kind of at the bottom line here. Right. As you alluded, operating income has essentially doubled in the last two years. And again you would attribute most of that to this kind of gateway transition. Is that fair?
- [59:54]
Drew
Yeah. And a little bit too from the more subscription revenue as well.
- [59:58]
Alex
And then again this kind of shift here has materialized in almost a doubling of Operating margin in the last two years, which is attributed to the shift from gateway to the payment processing and then again, some growth in that subscription revenue which we were talking about. Is that high margin, Is that offsetting sales and marketing? However you want to think about it, the net of it is operating margin has been increasing. Maybe you want to put a bow on it for us. Drew, We've spoken a lot about this before we get into the competitive section. Maybe just do a quick summary here for the people.
- [60:26]
Drew
Yeah, so right now they have about $3.9 billion in LTM revenues growing 22%. If you're going to do the math pro forma of Global Blue, it's closer to $4.4 billion. And revenues have grown at a 36% CAGR since 2019. So very high revenue growth rate. Of course, a lot of acquisitions embedded in that. But that's okay. That's kind of their, their business model. They do give an organic growth figure. And that's. That's 18%. It's not organic the way maybe most people think about it because it still includes revenue synergies from cross selling or upselling customers that were acquired in acquisitions. So, you know, take that one with a grain of salt. I'm not sure how helpful it really is to look at it that way. But, you know, big picture, they're doing about 310 million in LTM operating profits. And as we were talking about that gross profit uplift, you saw it flow through to operating margins. Operating margins 2019 were zero, but percent, they were negative 8% in 2020, largely because of COVID and a lot of their payment volume getting decimated because their end markets were, you know, hospitality and restaurants. And now they're up to 8% operating margins. And so that's been on the rise and very kind of nicely so. And so altogether they have about $200 million in net income, or about $2.15 a share. There's a little bit, you know, of accounting kind of thing going on where they have, basically they have this tax receivable agreement sort of situation with the umbrella C Corporation. It's a thing, you know, that's kind of become somewhat common lately. But in short, it's to benefit the old owners of the business for when it went public. There's a tax benefit to it. We write more about it in the report. That's going to collapse, though, soon. So that's good because it creates this big tax receivable agreement liability that flows through the P and L confuses everything. And so it was a $290 million liability in 2024. And then they get a tax benefit. And so it just gets confusing. So luckily that's going to go away and the share structure is going to collapse and simplify to going forward.
- [62:21]
Alex
Now, again, kind of a good overview here of, of the business. Let's get into a little bit of the competitive landscape. And again, a lot of competitors here is kind of coming at them with different aspects of the business in which they're competing on, whether that be from toast kind of competing on the end users to win that payment processing, or some of these legacy systems who deal with more enterprise that seem like it's just an absolute nightmare to rip them out. But why don't you kind of take us through those, like, segments and types of competitors and see where they should sit in them?
- [62:52]
Drew
So everyone knows, you know, payment industry is really big because it touches every single payment in every single economy. And so every transaction, there's payment processing revenue associated with that. And so there's a lot of different nodes in the payment vendor value network, a lot of people competing for Shift4 kind of competition. The way we want to kind of frame this is that even though shift war ultimately monetizes payment processing, they don't compete on payment processing. Instead, they usually fight on something else, like pos, for example. So they want to have the best point of sale system in order to ultimately get the payment processing revenue. And so what they're really competing on is ease of use, the system functionality and integration, price and support. And so on the one end, at the very kind of simple level, you have square. They're the easiest to set up, the easiest to use. They like to compare themselves, saying they're on the other spectrum of square, where they're for the most complex cases. You know, square is someone opening up a taco truck charging, you know, $3 for tacos, and has a very simple menu, maybe, you know, 10 items or something, altogether very little customization. Whereas they're going to be doing the Cheesecake Factory, which is known to have the most complex menu in the world, a bunch of chains, a bunch of locations, different states, all sorts of different issues that you have to worry about with that. So that is kind of their. Their core customer. So they do venues, they do stadium stadiums, are very complex environments, if you think about it, because you have a mass of consumers, 40,000 people coming all at the same time. You have to do parking, okay. Then you have to do ticketing, then you have all these different concessions, then you have you know, bars and restaurants there. Then you have merchandise, you know, people buying jerseys, stuff like that. Then you also have loyalty because you want to know who's buying what to be able to push them. Promos later on. There's also now people are gambling more. And so now they're trying to integrate with that where if you're gambling, you know, maybe on a sports bet or something and you win, okay, you can now use that as a voucher to go get a free beer, something like that. So all of these, you know, very common, complex, different nodes, different terminals, all this has to talk to each other and do so at really high volume because everyone goes to the concession at the same time. And then they've also pushed to do, you know, mobile in app ordering at venues, which was something that was harder for competitors. Copy. So that just goes to show how complex the environment can be. And it's, you know, the same thing with like a hotel resort, which maybe has not just, you know, hotel bookings, but they could have a restaurant there, they could have retail there, they could have a spa there, they could have a golf course there. They could also have, you know, like a retail store there and, you know, snacks and all that. So there's a lot of complexity in the customers they're dealing with. Now the way we kind of frame competition is that we have the legacy competitors who would deal with enterprise. Historically, Oracle's microsystem is, you know, kind of one of the biggest there, and then there's a couple others. NCR is also a standout, but you have these legacy kind of systems that are just positive. Then they work to connect with a gateway, like, you know, Freedom Pay or something, which is JP Morgan's, and then they work to connect to a different payment processor, like, you know, Global Payments, for example. And so you kind of have this patchwork solution, but that works for them because it's very customizable, it's very flexible. And so that's kind of the enterprise layer of competition. We'll say more about that in a second. Then you swing kind of down market a little bit. And that's where you get the players that are more like toast. They're more like spot on. They're like lightspeed. These are, you know, newer fintechs, kind of what you think of as a fintech. You know, the sleek white pos, you know, nice software. And they go out, they try to acquire a bunch of restaurants, a bunch of small businesses. Toast, as you can imagine from the name, started with restaurants, and they build Kind of a proprietary platform that does everything. It's the pos, the payment processing. And then they'll have a bunch of other software modules, stuff that'll help you run your business. They'll do stuff like accounting. In Toast case, Toast was built really just for restaurants. It was purpose built for them. And so they have a lot, a lot, a lot of functionality just for restaurants. Things that you may not think about doing otherwise. Like if I have an order that I'm placing in on a three course meal, maybe I want to know the timing of when to fire one thing versus when to fire the other in the kitchen. And it gets sent back to the kitchen. The kitchen now knows when to start different dishes and it could coordinate for different tables. Okay, maybe I want to put someone in a reservation at this time in this table, someone else at that. And I want to, you know, also account for the fact that if it's a larger party and they told me it was a birthday, that they're going to be staying longer. And so there's all sorts of different things that allows you to do. And it's very customizable for restaurants. That's why Toast is number one in restaurants. And actually we have an expert call interview with a past Chiff 4 executive and he even is saying toast is number one in restaurants by far. But, but Shift Forward is catching up. And they don't compete exactly on the vector of having the best product. Of course they aim to, but we'll, we'll talk more about that in a second. And then you also have kind of these other players that are, I'll call them stragglers, light speed, spot on. You know, they're making a good effort. You know, they're gaining share mostly against legacy competitors. It's a little harder for them to compete against someone like Toast. And then also now Shift four too. So that, that's kind of the competitive landscape. But it's important to note that Shift four is kind of an amorphous competitor in a way because they have different weapons. They could go after Enterprise, but they could also tell Enterprise, keep your Oracle Micros. Pos we can work with that. We'll integrate with that. We have 550 integrations. That's not a problem. Or then they could go to, you know, a small bar and say, hey, use our Skytab offering. It's fully, you know, integrated. Everything you need is there. We're not going to charge you more for the software modules like Toast Whale. We're going to give you an opportunity upfront Bonus. So if you have a contract to cancel, so we'll win you over and you know we're going to give you the hardware for free now you're just going to pay, you know, the monthly kind of 2999 per device or whatever it is. And so that's kind of high level the competitive landscape and how you should think about that.
- [68:37]
Alex
Yeah, and it is funny because I do think they're trying to be good at everything and not great at one thing. So I do feel like Toast is hey, and I think you alluded to it, right? 10 years of trying to get the perfect kind of POS and back office integration software for small business restaurants. And again, I mean I don't think Shiff4 is giving up on iterating. I mean they're definitely iterating. They understand their product has to get better, but it's good enough in a lot of instances. And of course you get the advantage of it being low cost. And of course with restaurants being, you know, very low margin business, I think every dollar counts. And again Toast, I mean one of their biggest sources of turnover is the fact that just restaurants go out of business all the time. And so again just acknowledging the fact that dollars really matter here. And if Shift four is able to kind of get scale, you know, and leverage their payment processing to make this money, then they can continue to really compete with Toast. But again, this isn't their end all be all right. Like they still have a lot of these other industries, more complex industries that they can continue to win on, which I think again have less sophisticated competitors. Like a Toast, you mentioned these integrated resorts or the stadiums and so they seem to win a lot of market share and hold those. So why don't you kind of just put a bow on this. Why don't you say where does Shift four win and lose? What is their value proposition to most of these customers?
- [69:55]
Drew
So it's a tricky question to answer because it's different for different customers. So if you're talking about venue and stadium, they have the best POs for that. They have venue next and then they acquired, you know, the second tier one. They kind of consolidated that market. So they have have the best product for stadiums and venues. And again that's a very complex environment. So that's kind of where they tend to thrive. You get to hospitality and hotels, it gets a little more mixed. You know they have 40 market share there, there's a lot of legacy players there. They do well because they can go in and say hey, you don't need to rip out, you know, your pos, we'll be able to work with your existing POS and still, you know, offer you these other things and that kind of helps them win that business. Whereas, you know, if it's a fully integrated offering and you say no, you got to rip everything out and migrate to us, that's not going to be that attractive for them because that's a big hassle. You don't want to have to rip out your pos. So you do kind of have that benefit there. And so the people they're going after in hotels, you know, it could be something like, oh well, you know, you're doing Gateway with us, why don't you also do the payment processing with us so you don't have to switch and we'll work with, you know, your pos. And by the way, if you want Skytab, we could also integrate that in and so maybe some, you know, know, newer restaurant that you have or something like that can work on Skytab and then you know, the legacy check in hotel rooms, that's fine, we'll support Micros there. And so they're very flexible in that regard, which is, you know, a benefit. And so that's kind of the hotel kind of customers. And then you get to SMB and it again it changes because there are some restaurants that are just like, I don't want to switch out my, you know, Oracle Micros or my NCR or whatever. And so if that's the case then that's fine. They could still work with them. I would say their core kind of customer there though is going to be more people. They're going to with Skytab which is their newer kind of unified cloud based platform. Having said that, that's also where Toast is the most formidable, is with restaurants. And so I'm going to read real quick this expert called quote from someone who was at Shift 4 for 20 years, an executive there and he says Toast. If you ask a hundred insiders which is better for restaurants, Skytab or Toast, the majority will say Toast. The reality is they made a very good, very well liked production. Skytab is a relatively newer product too. Programmers always explain it to me. They always say, like wine, it gets better with age. Software gets better with age too. Every version of software keeps getting better and better. Toast is a little bit older software. They worked out more kinks than Skytab. And Toast is expensive too. That is where everything gets interesting though. Again, I don't know, I'm just talking numbers out of thin air, one system, maybe toast, has 400 features and maybe Skytab has 300 features, but Skytab, you're going to get those for free. Toast, you're going to pay thousands up front and then you're going to pay more monthly. That's really the debate. And so then he kind of goes on to talk about how Shafur incentivizes their Salesforce a lot better. Where they do actually give out, you know, $5,000 early termination fees to merchants to get them over and sign a contract, you know, if you're doing $30,000 a month in payment volumes. And so that's kind of one way to market that. They'll, they'll be able to go after them a little bit, you know, aggressively. And so, so as it's kind of noting, you know, the Skytab, you know, it has most of the features, just not all of them. And so if you really need everything and you want to make sure it's all right, you're going to go with Toast. And most of the restaurant industry does. They're winning a majority of incremental market share there. Skytab, though, is cheaper though, not least of which because they don't have all these other modules they add onto it, which Toast does. And so, you know, maybe you want a separate module for payroll, something like that. Toast will charge separately for that. There's a bunch of them. You can could pull them up on their website and you could see all of these different add on SaaS fees. And so that's, you know, why people like Toast as a business model, because it's that SaaS revenue. But that's also why customers don't like it. And so that does make Skytap a lot cheaper, generally speaking. And so that's kind of a big aspect of this. And then the other kind of competitor we haven't said too much about is Clover. That is basically First Data's attempt to have, you know, a modern pos. And that's been, you know, doing pretty well because they have First Data, which is a big payment processor, backing them up. It's modern, it's sleek. They have more of an app store sort of approach there. So there's a lot of apps, integrations and plugins, so it's pretty flexible. But then all of these apps have like separate SaaS charges basically, or fees to use them. And so Skytab wins because a lot of the time they're giving those kind of modules out for free. And, you know, for example, let's Say you want to plug in for doordash for food delivery. You know, Toast is charging for that sky tab. It's free. And so that is, you know, a big win because that's obviously very important for a restaurant. And so, so getting those costs down is one of the ways where they kind of really win and compete there. Toast is, you know, a pretty well run company. I think Shift for executives would say so themselves. In the past, Jerk Isigman's actually kind of talked admirably about how they built their product, but they would just say one product isn't going to win the whole market. And so, you know, Toast has been trying their best. You know, you pull up some of their recent investor day slides. They had 70% incremental market share in Austin. I don't know why they just picked Austin. I don't know what's going on in the other cities, but. But that goes to show that it's definitely a pretty good product. But Shifor also has a lot of other opportunities outside of just restaurant. I don't really know where to fit this in, but they have a SpaceX partnership for example, and so they're doing all the payment processing for Starlink. The bigger Starlink gets that is a big payment opportunity. They think if it's as successful as it can be, it's going to be $100 billion payment opportunity. So they have all of these other kind of growth options out there. We'll talk a little bit more about that of the valuation, but that's just kind of a high level how I'd kind of characterize all this. And so just to summarize, the way you should kind of think about shift 4 is instead of thinking of them as what do we need to build for the customer to get the best product for them, think about it more in terms of how do we get their payment processing revenue. And then let's back into what we need to do to get that. And so then it makes sense because you know, with restaurants we'll acquire pos if we have to do that with enterprises we're happy to work with, you know, Micros or ncr, whatever legacy solution that we have to work with to get a SMB, we're happy to roll out Skytab. And all of that is ultimately about getting that payment based revenue.
- [75:48]
Alex
All right, but let's talk about really what matters here, which is does is this a good business? So how is it showing up in kind of their roic? Of course, you know, we look at businesses and I think Constellation is a great example of a business that you know, is very acquisitive and that's part of their business model versus kind of growing organically. Shift 4 Again they kind of have somewhat of an organic growth Runway because they have these acquisitions and they're kind of upselling to payment processing but again, very acquisitive. So let's look at how have these acquisitions been working out for them. Have they been good acquirers? Should we can continue to kind of give them this leniency as they, you know, embark on the biggest acquisition they've done? And a bit of a field that's new. Right. They had a lot of success in this gateway acquisition, but Global Blue, not exactly the, you know, original playbook. So what's ROIC looking like? We'll start there.
- [76:38]
Drew
Yeah. So if we kind of look at it consolidating everything just across time roic, there's actually three different ways that we wanted to look at it. So there's a no PAT basis, there's a cash flow basis and then there's their numbers of cash flow. Because I had some adjustments I wanted to make that they don't make. So the most obvious which is basically just stock based comp, but then they do have these other kind of one time expenses, stuff like upgrades to it, a lot of acquisition expenses too. And the question for a company that's you know, kind of main growth engine and very continually does M and A to consider an acquisition expenses one time, I think it's questionable because you know that they're going to have more acquisition expenses. On the flip side though, you also know that once they buy the asset, it's not something that you know, you need to capitalize and hurt them for forever because those, whatever the banker costs, the lawyer cost and all that, those are one time in nature. So I could kind of see that one both ways. So we did them all of the above. Basically, if you are looking at it on their numbers of free cash flow to get the ROIC, you're going to get about a 12% ROIC in 2024 LTM. It's a little worse though because now they have in their invested capital base the acquisition of Global Blue without the earnings. And so, you know, ROIC drops, they, you know, put out this kind of Target though of $1 billion in adjusted free cash flow. And so if we take that target they have, which they think they could hit, you know, in 2027, layer in a little bit of stock based comp that we're going to go Ahead and back out and some other adjustments, then we're getting about a 16% ROIC. So that one's a little more theoretical, but that would be a good ROIC. Otherwise, if we're looking at our numbers on no PAT, you're only getting, you know, 7% in 20, 24, 5% LTM on our free cash flow metrics. You know, it's roughly the same. And the other thing I want to bring up with their model, and this isn't a problem, it's just an accounting thing. And something I've seen, you know, people talk about the business differently is they don't rely that much on S and M as a means of acquiring customers. And so instead they have intangibles, right? And so they acquire customers in the acquisition. And, you know, they actually used to break that out separately. They would show off how much intangibles they attribute to the customer relationship. They don't disclose that anymore, but they had that as late as 2021. And so obviously part of this acquisition is to buy these customers. And if you're looking at it on a free cash flow basis, of course you're backing out the amortization. And so the cost of acquiring these customers is not really being captured anywhere then. And so I think that that does deserve an adjustment of sorts because if you are, you know, you're making a big acquisition, you get all these customers, the acquisition payment is, is, you know, flowing through in cash flow from investing, you're probably not including it anywhere then, because now once you get those customers, you're supposed to amortize the relationship. And now you're backing out the amortization and the cash from operations line. And so it's kind of invisible. And so that is something that I think kind of deserves to, you know, be thought about. And so obviously, if you're looking at it on, you know, a no pat basis, then that is including the amortization, which I don't think is an unfair thing to include in this case. And I know it's a little bit, you know, if we were talking about Constellation Software, I would say let's not include the amortization. And I would argue that's because it's one time in nature, it's not an ongoing cost to the business and you're not going to actually have to put that money back into the business. Again, it is a little similar with them, with the caveat that they are going to kind of continue to acquire new customers through this means, whereas Constellation, as businesses they purchase, are not acquiring customers or upselling them or anything. And so I could really see it both ways, to be honest. And it's fair, I think, to look at it both ways. But if you are trying to think about, you know, what is the actual cost of acquiring a customer, a payback ratio, I do think you need to include that amortization, not just the S and M. And so that's kind of a high level few thoughts that I have on that.
- [80:31]
Alex
Yeah, I think this business for me is it's a very, very complicated. I mean you have a lot going on and we didn't get into even all the accounting nuances that they have. Kind of like a non controlling and that kind of creates these weird liabilities almost kind of again going back to Constellation, it was IRGA liability and it messes up the P and L every quarter and you don't really know what's going on. I mean, do you feel like you have a kind of a clear picture of shift 4 or is there kind of, I mean, is it making it a little difficult for you Drew, to understand really? I don't know how good of a business it is. I think it's somewhat a little complicated to understand.
- [81:05]
Drew
It is. I, it's just I can't get a clean ROIC number. The clean ROIC number I'm getting, you know, they're high single digits. It peaked at a low double digit, you know, briefly, and then it's back to a high single digit and they're back to doing acquisitions that they're telling me they're doing well. And I, I kind of, to be honest, believe them that they're going well. But I can't actually confirm really much out in the numbers at all though. They'll give kind of one off disclosures of these different acquisitions, but it's not enough that you could actually tie it to an roic. So you know, I have a bunch of examples in the report of different acquisitions we popped up up and they'll say stuff like, you know, this is in 2Q25. CEO David Lauber said. CEO David Lauber said we invested $5.4 billion of capital since our IPO back into the business across three major categories. So $5.4 billion in capital is generated, an annual EBITDA contribution of $890 million and free cash flow of $514 million. And so I look at that and I think, wait, is that good or bad? I don't know because it depends on the timing of when that cash flow was generated. And all that because, you know, their IPO now was back in 2020, you know, almost six years ago. And so how much of that capital was invested six years ago versus currently? You need something more like an IRR to get that, because, you know, investing over $5 billion and then, you know, waiting five years to get, you know, a 10% return on invested capital on that number, which is. It's actually a little under that. It's more like 9%. That's not that great. And so I'm a little confused by this, to be honest. And then, you know, you could say, well, they're still under earning. They have more opportunity with their existing set. It's not at maturity. And this is what's depressing. You know, the roic, you have customers that they could still upsell without the need for them to do more acquisitions, and they have more opportunities there. And so I get all of that. I'm just saying I can't. I can't tie it out with the actual existing numbers yet. Maybe that can change. You know, if you're looking at, again, that $5.4 billion number, you're saying $514 million in annual cash flow, you're saying SBC of $60 million, roughly speaking, that gets you a free cash flow yield of 8%. And so if you invested $5 billion and then it took you five years to make an 8% return, you wouldn't say that that's necessarily great. But I don't know if it's bad because maybe they have more room to continue to compound that 8%. And so that's a tricky thing. I just can't get to the right numbers on all this. And, and some of the smaller acquisitions, they show, there's like, it's a little bit clearer that they're good, but they're kind of small, so it's kind of hard to tell. Like Merchant Link, they talked about. I kind of ran the math on that one. And so this is Jerich Isaacman, you know, CEO at the time, in 2023, talking at the Goldman conference. And he's talking about Merchant Link, which was $60 million acquisition for them. He says it probably represents over $100 billion in gateway volume. You know, and that $60 million acquisition got him in the door of a captive hundred billion in payment volume. Probably four years since the acquisition. We've likely fully synergized that down to probably a quarter of a turn of ebitda. And so if he's saying they paid a quarter of a turn of EBITDA so it's now generating over 240 million in EBITDA, which the math jives with that. That means they only captured, you know, roughly speaking, 40% of the payment volume. That works out. And so that was, that was a great acquisition. And I'm sure the other gateway acquisitions were pretty good, but it's these kind of ad hoc disclosures, it's kind of hard to know. I just want to know as a total machine. And that's one of the things in comparison with Constellation Software, all they do a lot of acquisitions and how much capital they deploy is very clear. But you can get a really clean ROIC number on them that's very high, close to 20%. And so that's not really a concern there. And so this is kind of the issue with M and A. And you're not really sure because there's this other thing that happens when you have earnings of an existing business. The thing that should should happen is that the business should retain those earnings and grow more regardless. Right. So if you have more earnings as a CEO, let's say to control, that means next year you have more resources. Almost no matter how you deploy that your earnings are going to grow. So they should grow every year. The question though is really what is the ROIC of that growth? Because if you have an extra hundred million dollars next year, you could put in the bank and generate, you know, $5 million in incremental earnings and you could say EPS grew. Right. But it doesn't mean that that was a good investment. And so it's just hard basically for me to triangulate all of this. And so that's a little bit of my, I don't know, frustration to be honest with all this, because I feel like maybe there are disclosures that they could have or some way they could present this that could make it a little bit cleaner to get to a real number of understanding what the return on these acquisitions have been.
- [85:37]
Alex
Kind of defend management here a little bit. I know some of the accounting can be a little confusing and hard to follow, but they have ostensibly made, made some intelligent capital allocation decisions. Specifically during, you know, kind of the low rate environment. We look at Gary who, you know, wanted to save a couple basis points on a floating rate term loan. Gary Friedman of rh. But of course I think they were a little more strategic with some of those zero interest rate deals. Maybe you could take us through some of those kind of highlights of positive capital allocation that you've seen as a shareholder.
- [86:05]
Drew
Yeah, So I mean like they were Pretty good timing wise with some of these convertible notes. And 20, 2020, they did a $690 million convertible note at 0% for a conversion price of $80. Then they did another one in 2021. 630 million at, you know, 50 bips was the coupon there. And so they've been pretty good at raising money. You know, they've also diluted, you know, the shareholders a good amount through the acquisitions. And so if you're looking at just Shares Outstanding in 2021, it was 55 million LTM, it's now 90 million. And you know, they have been buying back stock, but they've also been and issuing a lot of stock through those acquisitions. And so that's a part of it. Global Blue, though, it's, it's going to be a good amount of debt that they're putting on the balance sheet for that one. We'll talk more about that momentarily. But I kind of just wanted to get a sense of, very roughly speaking, whether or not these share issuances were like dilutive or not. And this isn't the best metric, but if we're looking at gross revenue, less network fees per share. So in 2021, that number was $9 and in LTM that was almost $20. So that growing a good amount does suggest, roughly speaking, that, you know, these aren't value destructive necessarily. Again, you'd kind of have to tie this back to the roic. But this is, you know, at least kind of suggestive that they are pretty good at raising capital at good times and all that.
- [87:20]
Alex
So let's put all these pieces together and we're kind of at that portion of the discussion where we're going to talk about, you know, valuation, the reverse DCF and what assumptions an investor has to make for this to kind of make sense. So why don't we talk valuation high level here? What's just kind of a back of the napkin math? What kind of multiple are they trading at right now? Which of course will caveat. A multiple is a shorthand dcf. Depending on how you use it, it might be a pricing, it might be evaluation. Okay, that disclaimer was said. Now let's talk multiples.
- [87:50]
Drew
Let's talk multiples. So if you are just looking at their free cash cash flow figure, which I'm going to take Shift 4's number and I'm just going to back out stock based comp from that, that's about $500 million annualized for 3Q25, because we're going to want to Capture Global Blue in that. And then if you are doing kind of an EV to free cash flow multiple, at the time of this report it was 19 times. It's now dropped down to about 16 times. And so that's kind of where that's at. And then on a gross profit multiple, you're looking at roughly, you know, three and a quarter times gross profit. Profits is what they're trading at. So when we wrote this, you know, it was a market cap of 6.2 billion 60 at dollar stock price and now it's down 15% to, you know, 5.3 billion. Enterprise value is going to add about $3.3 billion in net debt to that. So you're looking at about $8.5 billion in enterprise value. So a lot of debt on the business right now, which is I think one of the bigger reasons why the stock sold off because of how much debt they put on it during that Global Blue acquisition. You know, I think in management's kind of viewpoint, they think that that just makes the most sense versus diluting the shareholders more now in terms of ways to look at it. You know, we do the full dcf, which we could talk about in a moment, and some other growth opportunities. They put out though, this 2027 target of exiting the year at a billion in, you know, adjusted free cash flow. So that's, you know, two years from now, basically you're annualizing a billion dollars. And if you want to just kind of use that billion dollar number, the 2027 target you're looking at about, you know, nine times is what currently that is trading at. And then, you know, of course you should take in account, you know, the two years of cash flow. And so if you're kind of adding that to, you know, the enterprise value in the form of, you know, debt reduction or stock repurchases, that could bring that down another turn to, you know, eight and a half, eight times multiple. So the multiple is definitely pretty low in this business. So a significant amount of, of investor skepticism on it or maybe confusion to be honest. And so getting them there though, just to kind of get some idea of the assumptions they're talking about, kind of they give these three case scenarios and one of their last investor presentations, they call it a sit on the hands case scenario where they're going to do a three year CAGR in the high teens. Then you want to add in the impact of Global Blue that's going to get you to 25. And then in the most likely case somebody other M and A is going to get you a 30% and that's a gross revenue, less network fees. So that's how they're thinking about how much they're going to grow. And then that all flows down to adjusted ebitda, you know, proportionately. So, you know, high teens adjusted EBITDA CAGR in the sit on our hands with Global Blue that jumps to 25 and then with other M and A that jumps to 30%. And so that's kind of the scenario that they paint there. And so, you know, at the multiple it currently trades at, you could say, you know, investors don't have a lot of fake faith in that. And so it may be some aspects of this business that aren't, you know, the highest quality in the world, but it is still, you know, a sticky business. People do not rip out their payment processors very often. There, there is some natural churn, but it does not tend to be that high. And so all of this is something, you know, an investor should think about. And then, you know, in our reverse dcf, which we do, we sensitize for the free cash flow margin as well as different revenue growth growth scenarios on the free cash flow margin we try to capture basically, we do basically a negative free cash flow margin in some of the scenarios which assumes more kind of acquisitions are happening. So free cash flow is actually negative for those periods of time because you don't have any cash flow paying out. And maybe you're actually increasing debt or equity issuances at the time. And so, you know, mathematically it kind of all works out and can handle a negative free cash flow number. But that's just one kind of, of scenario that we were running. If you do end up downloading the report to see all that, and then we run all these other growth scenarios too. And then, you know, Speedwell members can of course see the return of outputs on, on the table on, on page 80. And so there is, you know, the, the reverse DCF there, if you need it, you know, it's only at a, I guess what I say, eight or nine times multiple now. So I'm not going to pretend that the reverse DCF is of the highest use when something's trading at that multiple. But it is still interesting. You can, could see all of the assumptions embedded in that. And then it's a lot easier as an investor to say, oh, am I okay with the assumption of gross revenue, less network fees, growing this amount and a free cash flow margin of X and then I get this much of a return or in my worst case, scenario I get this much of a return and I could think of that as kind of being my downside. So it is still helpful.
- [92:11]
Alex
And again, this all comes down to the probability of this world happening or not. And again, the risk section here, I think it's a really execution based risk section. And to me, and I think this is kind of, you know, I'm not a unique insight. I think the market felt this as well, which is they took a big swing in something that's very unknown, which is this Global Blue. And can they kind of use that as a foot in the door with cross selling to this payment processing? Of course, they've been pretty successful at these kind of synergistic acquisitions before, which you know, is usually in business school they'll tell you that acquisitions don't work and synergies don't work and don't count on them. But they seem to kind of have the proof in the pudding, which they've been quite successful then. But why don't you take us through what worries you the most about the company?
- [92:56]
Drew
Sure. So the biggest one, honestly it's kind of Global Blue right now is floating out there. There's a question of how well their strategy is really going to work with Global Blue in as much as it has with previous companies. And, and now, you know, that's a big portion of the business just valuation wise. And so that's kind of something that I think gave a lot of investors hesitation because, you know, maybe you're getting to know the business and all that and then tax free shopping is a different business. And I get what they're going to say. We're doing the same playbook. It's something else. It's a good valuation. It's still a decent business in and of itself. But we have all this cross sell opportunity and I could understand all that and they could be right. It's just, you know, as an investor it does feel like, like a little bit of a different business now that all of a sudden you have to learn and it's a big portion of the valuation. And so that's kind of, I think one of the biggest things there. And honestly my base rate would be that it goes fine. It's just, I don't know how you really have that much confidence in it because it's just a totally different business and you haven't seen that many proof points yet. Well, probably happening is, you know, you start to see some, you know, proof points and then you could have more confidence as an investor and then maybe at that point, you know, the market really catches on quickly, or maybe it doesn't. You know, in the case of Meta, there was multiple quarters of evidence that all of their spend on AI was yielding results in terms of, you know, higher conversions, time spent and all that. And people didn't react to it yet. And so that's something to kind of think about. And other competition, you know, it still exists, it's still a lot of competitors, it is a competitive industry. But I feel like we've kind of talked about that and gotten comfortable with that aspect. But it's always possible. You know, there's also the fact that there is a lot of debt, $3.5 billion of debt versus annualized free cash flow, 500 million. That could take them a while de lever, and then they still want to do more acquisitions and, you know, who knows? What if there is, you know, another big economic downturn, another, you know, pandemic or something that could really put them in a rough position. This other risk, I don't really know how to think about it. It's the most far out risk by far, but also like the most formidable, which is something of like a new payment system. If you're thinking about crypto, generally speaking, the best part about crypto is that there's no fees on it. There's a lot of bad parts about crypto, but. But it is the case that a traditional payment system is very slow and also expensive. And if you were able to use something like crypto, or it could not even be crypto, it could be another sort of network that's like a walled garden network. An example of this would be something close to, you know, maybe if you're thinking of square, like you have the cash app on square and then use the Cash app, the cash in the wallet, to go and spend at a merchant. This never really came to fruition, but that was kind of a fear for a while. So. So anything like this where it's like a totally new payment system that kind of gets layered on the top, or it's just like a separate from kind of the traditional system and maybe it interacts a little bit with it where you're transferring money in or out, but then once you get in there, it's like unified. You know, you have your own E wallet, the E wallet goes to a merchant and it doesn't even touch, you know, the traditional payment processing back end. So this is a far out risk. I don't really know how formidable it is and really what to make of it, but that's something that's there. You know, the other thing is just kind of executive distraction. Jared Isaacman is now going to be the NASA administrator. And so, you know, is he going to be a little bit distracted with that and not focused on Shifu? Yeah, probably now, you know, he's not CEO anymore. But you know, the other aspect of this with you know, Jared Isaacman getting into NASA and all that is also he's friends with Elon Musk, which is originally how it kind of got got the recommendation for NASA. And so maybe there could be frictions in the relationship. You know, maybe they something happens with NASA versus SpaceX and SpaceX decides to remove Shafur is kind of the payment processor for them. Or maybe, you know, he gets targeted for something else for being friends with Elon Musk and maybe is seen as having too close of ties with the current administration. That's something else going on. The other one is, is just kind of generally the ROIC risk that we're talking about earlier. We haven't fully been able to prove out all the ROIC on kind of the acquisitions. There's also so, you know, vats change for any reason that'd be bad for the global blue business. Antitrust scrutiny on the acquisitions that's kind of out there. And then you know, maybe the largest one now is also just integration issues. A lot of acquisitions, a lot of different businesses to put together. They've been pretty good generally speaking at kind of dealing with all that. But global blues and especially big business, different culture and all that. So maybe that slows them down and just really doesn't go as they expected. So that's just a bunch of different risks that that we have out there now.
- [97:11]
Alex
Paint the rosy view. Because there's definitely a rosy view. I mean you have a business that and again payment processing somewhat commoditized, acquiring the payment processing very difficult, not commoditized and as very sticky once you're on it. So to me it seems like they've done a great job of being this efficient funnel machine of just gathering payment processing and then using creative acquisitions. Again, no one was doing Gateway, you know, using Gateway to kind of cross sell these payment processing. Maybe the new thing is using these bad companies to cross sell payment processing. I mean they've done it before. Why not have the credence to let them say they can do it again and what's kind of a good outlook here and we can kind of leave it there?
- [97:51]
Drew
Yeah, I mean the Rosie outlook is basically just that they're able to Achieve their guidance and grow the numbers they say they're going to grow. You don't even need these kind of herculean scenarios when you're talking about a company that's trading at that low of a valuation. You know, our numbers are around nine times. Even if you want to add some conservatism to that, it's still, you know, a low digit earnings or cash flow multiple there. So that's kind of what's already happening right now, just with the existing business and all that and a little bit of a success from Global Blue and not really counting other acquisitions and all that. And you know, we have another expert call interview with someone who is from Shafur at 20 years and he talked about kind of their ability to convert 10% of this trillion dollars of volume that Global Blue had. And you know, he said in the past that they basically were able to do 50 to 60% conversion when they were doing acquisitions of, you know, pos like pos itouch restaurant manager, those were in the restaurant space. And you know, he's saying that he does think that they could get to 10%, maybe even 15%. And then you also have, you know, some of these other acquisitions we talked a little bit less about, you know, that they acquired a European payment processor and so now they can expand internationally. They also can move into nonprofit donations. They made an acquisition there, also crypto based donations. And so there's these, all these other avenues. SpaceX is another one. And so there's all these other growth options that like if any of those hit too, then growth accelerates even more. And then also, you know, maybe they do find another one of these little niche tuck in acquisitions. That could be another great one. Maybe not as good as Gateway, maybe you know, some other aspect of payment processing. A lot of these companies too, their valuations have been been pretty hampered down and so there is, you know, a lot of opportunity for them out there. And again, it's not, you know, it's tricky because I think a lot of the businesses we look at are a little cleaner and also maybe, you know, higher quality. Just in, in terms of the actual core business. You don't really have competitors in a lot of the businesses we look at, which is nice. But in this case there is competition, but they've been faring well against the competition and they've still been growing in the face of competition and even, and you know, there's not going to only be one winner and these are growing markets. And so again, you just kind of don't need These crazy assumptions in order for it to work, it could just be a simple matter of they execute on what they say they're going to execute and they do a good job of returning capital in the form of stock buybacks, which they have started to do and they are amping up and that's all they really need to do.
- [100:08]
Alex
You know, luckily I didn't make you do the bull case, bear case this time, which you know is a little bit difficult, which is the 42nd risk. I let you kind of expound a little longer this time, which I think is positive. But again, find the full report@speedwell research.com Drew will be having a follow up interview with the CEO and possibly the CFO on the company. So I think this is a great primer before you kind of listen to that interview. And of course, the YouTube is always cooking with new videos. I don't know what's going on next, but Drew's coming out. He is pushing those out. I didn't look at his YouTube page for a week and all of a sudden there were nine new, very good videos. And I go, man, I like what Drew's doing here. He can't be sleeping a lot, but I like it.
- [100:46]
Drew
I'm not. But thank you for listening to Shift4 and we are really excited to host the CEO and also I believe the CFO is going to be listening to that call. So if you have questions again, you can reach out to us on Twitter. We want to make sure we get them all covered and get to the bottom of what the market thinks and investors think of Shift four and ask the executives directly. So I'm really excited for that. And until next time.
- [101:09]
Alex
Until next time.