Toast: Sticky SaaS - [Business Breakdowns, EP.247]

[MUSIC] This is Business Breakdowns. [MUSIC] Business Breakdowns is a series of conversations with investors and operators diving deep into a single business. For each business, we explore its history, its business model, its competitive advantages, and what makes it tick. [MUSIC] We believe every business has lessons and secrets that investors and operators can learn from. And we are here to bring them to you. To find more episodes of Breakdowns, check out joincollossus.com. All opinions expressed by hosts and podcast guests are solely their own opinions. Hosts, podcast guests, their employers, or affiliates, main-aintained positions in the securities discussed in this podcast. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. >> This is Matt Russell and today we are breaking down toast. My guest is Sean Barrett, founder and CIO at Counter Global. Counter Global manages a concentrated portfolio of businesses and developed markets and you may recall Sean from an episode last year where we spoke about a name in the alternative asset manager space, EQT. Today we are here to cover a business in a completely different industry and that is toast. It's a wide ranging discussion. I think a lot of people are wondering what software names are particularly interesting in this moment in time. And Sean gets into that and much, much more. So please enjoy this episode. All right, Sean, it is great to have you back. Today we are talking about toast, which is a name that we previously covered. And we do like to revisit names when there are noteworthy things going on. Maybe the stories changed a little bit. And I think we'll get into some of that here. But maybe we could just start off with a simple introduction to toast for those that aren't familiar and your own history with this business. And what brought you to it, some of those dynamics just to set the stage. >> Matt, great to see you. Thanks so much for having me back. Very excited to talk about toast today with you. It's just a phenomenal business. It's a 15% position for us at Counter Global. So it's also a high conviction name. But for those in the audience who don't know about it, toast is really the category killer for FMB point of sale and software. And they're the operating system for their restaurant customers, super mission critical, super innovative category killer. I've had a long history with toast. I first invested in the business back in 2020 during COVID. And I remember management team sent me the model and I opened it up and I looked at it. And I said, this can't be right. These numbers are too good. Retentions too high for the restaurant industry. I think I'm missing something here. And I called them and I said that. And their response was, nope, you're not missing anything. These are the numbers. So look, it was a great business back then. I think it's an even better business now. Super excited to break it down with you today. >> Yeah, I think you got into some of the words which make it thematically very interesting which we'll get into. Maybe fast forward to today and you could set the stage just in terms of the financials of the business, just a snapshot or overview about where they are today. Any comparison to where they were in 2020 and how much the dynamics have changed. I'm just curious if you could share that as well. >> Oh my gosh. Yeah, the business has changed a ton in the last five or six years. Today it's about a $12 billion enterprise value. There is some accounting noise in there. So when you open the 10K, you'll see that they have to account for interchange revenue as their own. But if you parse through that noise, the business does about $2 billion of recurring gross profit with about 35% EBITDA margins, minimal catbacks, really high customer retention as we mentioned on both a gross and net basis. It's night and day from 2020. In 2020 and 2021, they were in hyper growth stage. Again as a public company in the early days, EBITDA margins were substantially negative. Stock-based comp was really high at 30% of revenue. Today you have a company that is still growing very, very quickly, 25% gross profit growth. We think that can continue for a bunch of years. But it has high quality of earnings. And so we're looking at 18 times next year's Gap PE right now. We'll get into the valuation at some point, but 18 times next year's Gap PE for a durable 20% revenue compounder and 30% EPS compounder. So it's a phenomenal business and it's remarkably cheap at this point. On the $2 billion in reoccurring gross profit, I would have assumed this is a transaction-based business. When you mention recurring, is that just like a floor level or is it truly recurring in nature with some type of contractual basis? I think that's a good thing to touch on. When the company describes its gross profit as recurring, I think it's reoccurring in nature. So something like two thirds of the gross profit is going to be from payments where they get a net take rate. That's how they monetize. Even though the customers on average are using seven modules, they monetize through payments gross profit. That's about two thirds of the business. Then software gross profit is about a third of the business. It is reoccurring in nature in that if the customers turn off toast, they can't run their business. The retention rates are tremendously high. Then payments are a funny thing as far as being recurring in nature. They're definitely more volatile than contract-based business, but they also grow with inflation. They grow with GDP. It's really aligned with the customer where their revenue becomes your revenue as well. There's a lot of nuance to these phrases or words and semantics, but it is helpful to understand exactly where that's coming from. Then I guess just in terms of revisiting it today, hearing the 18 times next year's gap earnings is surprising for a number when you reference those growth rates. What else would you mention just in terms of where we are today and why it's worth bringing up and talking about? I think the business has really evolved in a way that makes it more attractive today even than it was a few years ago. Then I think from a valuation perspective, no surprise to you. There's been a pretty severe debate in public markets around the Saspocalypse, Sass's Dead narrative. While we think there is a lot of disruption out there in the software space, particularly around coding and DevOps in some cases, there are also a handful of category killers, vertical market winners and infrastructure software companies that are thriving and in a better spot now because of AI than they were a few years ago. But it's important to touch on the Saspocalypse debate because we aren't blind to this. There's a real transformation in the market with AI. When it comes to vertical market, multi-tenant Sass category killers, this actually rhymes with the movie that we live through in 2015. I think we should talk about it for a minute. If you go back to 2014 or 2015, open source had been around for a long time, but AWS started putting open source software on its platform and it became available to the masses. Pretty much immediately, public companies software multiples collapsed to three or four times revenue, basically where they are today. Everyone started asking the question, why would anyone pay for software when we have these free open source models on AWS? Sounds pretty familiar. That was a tough time to be a software investor in public markets. It took about 18 months and when you fast forward early 2016, the category killers kept putting up numbers. They kept innovating. Some of them were using open source internally, most of them were. And the stocks went parabolic. There are some differences today, no question, but it rhymes with history. And I think at this point, we feel like we have a generational opportunity to invest in something like toast, 25 plus percent compounder category killer at a gap net income multiple. When you talk about the transformation of the business, particularly when you mentioned from 2020 to today, what stands out the most in terms of that transformation and what's happened? This business is really evolved. And at this point, it's firing on all cylinders. I think the biggest evolution that you're seeing today is the result of a ton of hard work that happened three to five years ago. So if you go back to 2020, unprofitable business, single-tam, really just focused on the core SMB restaurant customer in the US, you fast forward today, very profitable business, 35 percent EBITDA margins and growing with five times that the company is unlocked through a ton of innovation. So it started with SMB restaurants. They innovated starting five or six years ago, building products for the enterprise, building products for grocery stores. Now they're selling into liquor stores. They've started quietly selling into gas stations. That's a new opportunity. They're selling into hotels, FNB and retail and hotels. And then they've built an international team and an international product that's already live in the UK, Ireland, Australia and Canada. And they'll keep adding markets from there. What you had five years ago was a single-tam, highly unprofitable, hyper-growth business. And so this business has been a 97th percentile grower for the last three years in public markets. And that's against a lot of hyper-growth semiconductor names, 97th percentile grower, while also taking margins from negative to substantially positive, while also innovating like crazy, expanding into a bunch of other markets. new markets, it's incredibly rare to find a 10x opportunity in public markets. We think we have one year just based on the current product offering. In terms of that offering and what they're doing for the customer, can you give that overview now in terms of everything that they're offering to their customer base, what's actually happening as they're selling in what's on the other side of that offering? Toast is really the full operating system for their businesses. Think of it like Shopify for restaurants. It's the point of sale, digital ordering, payroll, automated inventory management, real-time reporting across multiple locations. Then they have complex hardware. We should get into the supply chain, but they've built a really great hardware business as well. Because it's a modern multi-tenant SaaS solution, they can code once and then deploy all the updates with new AI models and with new technologies rapidly to the whole customer base. They've got a huge data advantage that's really important as they go build new products and that's already starting to show up in their AI offerings. Most people underestimate just how complex the customer workflow is at a restaurant. Most importantly, customers really love Toast. We do a ton of custom survey work on all our companies, some notable takeaways as to why customers love Toast so much. Toast has a net promoter score of roughly 50 with 95% of respondents indicating they would recommend Toast. Just for reference, a net promoter score of 25 is considered really good. 30 to 50 is considered exceptional. They've got elite customer satisfaction metrics. On average, customers are using Toast for seven modules. This isn't just a point at sales system like you might see with some of the competitors. It's a multi-product mission-critical operating platform for its customers. Toast is sitting about a 20% share of the US restaurant market with more than 160,000 locations, but they're actually winning roughly half of all new restaurant openings in the US. That's what really gets us excited. It's the definition of product leg growth that's leading to very rapid market share expansion. And the network effects in this industry have proven to be really strong over time. Usually, the top one or two players in the restaurant industry end up with 40 or 50% share. It's product led and they're gaining a lot of share on the back of the innovations that they made over the last five or 10 years. Anybody that's spent time working in a restaurant as a high schooler, college kid, being in front of house, even just seeing how the point of sales systems work there. But how much it flows through when you step back and think about perishables, the inventory management, it runs your business. It's notable to think about that. You helped explain a little bit about the revenue model recurring, reoccurring with all of that different offerings coming into play now. What does the revenue model look like just in terms of what's transaction-based versus your paying for this software? How do they go about that? The revenue model is really a mix of a bunch of the different offerings they have. From a high level, you have payments, gross profit. We have SaaS or software, RPU, and then they have hardware and then a small portion of revenue from lending to restaurants to help them grow. And that's a nice profitable business. The whole business is consumption based. So it aligns well with the customers. It aligns well with where the world's moving with AI. But let's break down those revenue line items for a second. If you start with the payments piece and you look at a let's say a dinner order that's $100, something like 3% of that will be interchange. $2.50 will go to the banks and the networks and other costs as part of the interchange. And then about 50 cents or 49 basis points goes to toast as a net take rate. That 49 basis points has been moving up over time as it's reasonably under monetized versus what you see in the rest of the space. Most competitors charge 75 bips to 125 bips from a net gross profit take rate perspective. Toast also has some opportunities over time to optimize costs as they get bigger. They've got about 200 billion of volume on their platform now. That makes them in aggregate one of the biggest merchants in the US. So they should be able to optimize over time and increase that net take rate. On the net take rate that 50 cents versus 75 cents that delta there. Who is that negotiated with? It's effectively what they make from the customer from the restaurant after all is said and done. So if an interchange fee is 3% and two and a half goes to everyone else, they can take the 50 bips or the 50 cents at the end. But it's not a big negotiating point with restaurants. They tend to see it is reasonably priced certainly against what they see in the market. The alternatives would be charging 3.25% is like where it's netting out for the restaurant. Is that 75 bips showing up there? It could and there's also a mix of card present, card not present, mix of credit and debit actually matter when you get into the nitty gritty. But if you look at square, for example, last I looked square was monetizing it's something like a 1% gross profit net take rate across their business. Square has a nice business at the low end of the market for smaller merchants. But they're not offering a robust toast like operating system on top of it. That's a pretty pure payments cop that you can look at and they're monetizing it about 1% gross profit take rate. Understood. I'll let you continue with this software side of things. Yeah, on the software side, we talked about how robust the operating system is. Toast charges something like $300 a month to $500 a month to its customers to use the software suite as well. And depending on the customer, they might use different modules. They tend to bucket it into like good, better best type of packaging. But at the end of the day, when you combine those two things together, the customer is paying something like $10,000 a year to toast on a total base of $1.3 million of revenue for the average customer. Hardware is a loss leader. So they do charge a nominal fee for their hardware when a customer starts up the business. There's kitchen display systems that connect the front of the back of house. There's toast go hardware. It has to be pretty advanced so it can deal with water liquids dropping, making sure it doesn't break. It's actually a complex engineering fee to build this kind of hardware. And then they make a little bit of money from lending to their customers to help them grow from an investment standpoint. It's a very easy business to model and to predict, which is always nice for my seat. So you look at the five things that matter here. It's location count payments, SaaS, RPU, margins and multiple. All of those things historically have been pretty relatively predictable. We like it from a predictability and modeling perspective as well. On your hardware point, does every customer have to have toast, hardwares or anything that can run purely on their software? Every toast customer has to have the hardware. Toast, when you walk into a restaurant, you'll usually see some sort of payments dongle at the front desk. You might see some sort of bigger screen that the customer is using or the restaurant owner is using. And then you have kitchen display and you have to go handhelds for the waitstaff. Toast went down that road of building specialized hardware many, many years ago. It's funny because a lot of the competitors that came out over the years tried to leapfrog them and take the easy road, which was building an app and then asking their customers to just download the app on an iPad. Turned out iPads don't work very well in restaurants. They break all the time. They don't do well with water and liquid and heat. What was a shortcut at the beginning for some of those competitors actually led to their demise or made it so that they couldn't gain share. And in the end, the customers came back and said, this hardware from Toast is actually really powerful. It's purpose built for the restaurant and I wouldn't want to use anything else. Interesting as it relates to the SaaS apocalypse as well and how hardware makes a pretty big difference with some of these industries and particularly those that can use it for their updates and whatnot. So interesting to hear there. I totally agree with that. It's funny. It's not like a total halo business. Hard asset low ups lessons, but there are aspects of it. You have substantial hardware involved. You have physical presence. You have feet on the street. You're in the four walls of a brick and mortar restaurant. So to your point, I actually think it's an important part of the story. On the below the line profitability dynamics, how has that evolved over time? Would have been the big drivers there in terms of the changing of the profitability profile. I think this is probably a part of the story that deserves more time. At Counter, we talk a lot about product and profits, companies that can lead with innovation, lead with product leg growth, but also do it with really high profitability. There aren't that many companies in the world that can do that. They can sustain really high growth with great profitability at the same time. Toast is definitely one of those companies. We talked about 97 percentile gross profit growth in public markets, pretty exceptional. And management says they can maintain 20 plus percent growth for many years ahead. They just actually said that yesterday at a conference again. At the same time, margins have gone from minus 16 percent in 2022 to roughly 35 percent today, going to 40 plus percent, which management has said is aligned in the sand and then they'll continue from there. There's a ton of operating leverage in this business where they've seen operating leverage is certainly in sales and marketing, where that numbers come down a lot as a percent of revenue. a naturally as a company scales, you've seen GNA come down quite a bit as a percent of revenue. And then R&D, this has been a really interesting new lever for them as they've incorporated AI into the business internally. They've shipped more product in the last two years than I've ever seen them ship. We'll get into their AI offering. It's super advanced. It's very impressive. And in the last two years, R&D expense in dollar terms has not grown, basically barely grown. So you've had a business that's doubled in size and R&D has been relatively flat. They're starting to grow R&D again. They'll continue investing. This is an innovative team that thinks super long-term. They're not going to sacrifice their long-term opportunity. But there's been a lot of operating leverage in the business. And we just see that continuing as the business scales. Maybe you can get into that AI offering and what they're shipping. How does that show up? It's interesting to hear. We hear a lot about experimentation. I think we're all doing a lot of experimentation. It's another thing to ship things that your customers are using. So how does it show up in the business and what does it look like for customers? AI is the best thing that happened at toast since they're founding probably. Product has always had advantages versus the incumbents and versus the competitors. But if fast forward to today, the product has substantial data advantages. So they have 160,000 restaurants on the platform. They see local data everywhere. But they can see that because it's a multi-tenant SaaS cloud platform. Not to get too advanced here. But with multi-tenant SaaS, you can see all the data in real time. You can give product updates in real time. And then the gap against your competitors gets much wider. If you look at an on-premise offering, open AI is coming out with a new model every week. Clouds coming out with a new model every week or two. If you're an on-premise platform and you have to send a technician out to a restaurant to update the server every couple weeks, I mean, good luck. It's not going to happen. And it doesn't make any sense. It's not rational from a financial perspective. So AI is widening the gap for toast versus its competitors. I think just to give you a couple examples of where they're innovating what they've done in AI, the first thing they came out with was something called toast IQ, which is their AI offering. Customers love it. It's effectively a conversational AI offering that combines it with a system of action. So you can talk to your toast IQ. You can ask it questions. You can make menu changes across the board. That sounds simple. But if you have multiple locations and you want to change prices or change menu items, and you're also hooking up to the market places, that used to take an owner all weekend. Now you can just talk to your toast IQ and make it in real time. You can have real time analytics. You can have custom analytics. So let's say you have multiple locations. You want to say, Hey, toast IQ, can you tell me what this location is doing year over year with these menu items? And you can break it down into a bunch of ways of looking at it. It also is real time inventory management, where if the restaurant's running out of produce of a certain kind at night, the system will actually automatically order new produce, fresh produce from Instacart business or other local vendors. It's a gentick in nature. It's an advanced AI model in nature. And the customers absolutely love it. I mean, we've heard 50% of customers are actively using toast AI, toast IQ on a weekly basis. The new offering that just came out that's super exciting is called toast grow. And it's within the AI offering. It's an automated marketing engine for restaurants. Restaurants spend a lot of money on marketing. Generally, a restaurant will spend one to $2,000 a month with a marketing agency for Instagram and local marketing. And they don't see a lot of uplift. They still have nights of the week that are just going to be empty or going to be more quiet by nature of local behaviors. What toast grow does, it looks ahead and it takes data from the past and it takes data from restaurant to round you. And it might look and say, okay, this next winter Tuesday in Boston, historically, is really, really quiet. Let's go out into a local promo with SMS texting to people who have been here before. Let's put up deals on the website. Let's do an Instagram promotion. It does it all in real time automatically and it does that for about $500 a month. Historically, just over the last month or two, as people have started using this, they've seen an 8% uplift in total revenue. Remember, we talked about a restaurant on average for toast doing about 1.3 million of revenue. So this product that cost $500 a month as a SaaS module, by the way, nice uplift could be 100% uplift to SaaS RPU gives you about a 20X ROI right out the gate. So that's the kind of stuff they're doing in AI. We talked about some of the internal leverage as well that they're getting with R&D. But the product roadmap is largely AI driven. It's largely agentic driven and then management would tell you as they did at a conference yesterday that this is going to be the next leg of their revenue opportunity as well. The 8% whether you measured it in 20X or just think about restaurants, the margins that they operate at how razor thin it can be. It is material for that customer base. On the competitive landscape, I truly fail to appreciate how much toast was doing for customers. Just in terms of how deep into the restaurants operating activities they could be when it relates to inventory management, marketing, all of these different things. How do you define the competitive landscape? I'm curious how many others are doing quite as much just in terms of the breadth of different activities. The competitive landscape, I think, is a real strength of the story here. Just to start out before we jump in specific competitors, big question is why does toast win? They win because they have great product that we talked about. They have happy customers. Then importantly, they have more profitable customers. A typical restaurant might have 10% margins. It's a low margin business, as you mentioned. A typical toast customer from our work has something more like 15% margins. They're taking home 50% more dollars for the restaurant owner. It also means that toast restaurants survive more often. That leads to higher retention for toast and it leads to happier customers. The interesting thing about the competitive set, I would break it into legacy and modern. You've got about half of the market that's still on legacy platforms. That's stuff like NCR, low-ha, oracle, micros. Those are companies with on-premise software, on-premise servers. Generally, as we talked about, a bad fit for a kitchen. You don't want a hot server sitting in the back here kitchen or in a closet near your kitchen. That's what really opened up the door for toast to be the first successful scaled cloud-based disruptor. On the more modern side, you've got square. They have about 5% to 10% of the restaurant market. They do really well in the lower end or the smaller end of the market, where it's a less advanced offering, really more just a payment stongle. Now, they are innovating and they're innovating a more rapid pace than they used to because I think they see the restaurant industry is actually really attractive. They aren't winning from toast. They're mostly winning from legacy and we think from Clover. Clover has about a 15% share. That's the subsidiary of Fyserve. It's been publicly noted that Fyserve has been overleverred. They've acquired a lot. The stock has been a mess and I think they have some real issues to deal with with regards to leverage if they want to survive. As a result, they're not innovating and customers have noticed. They've been losing share even on the modern side. One player to watch right now is DoorDash. It's no secret. DoorDash has been out piloting POS solutions with their customers, but I think maybe they did that in response to toast, which very famously about a year ago started offering free delivery. That's a real innovator's dilemma for DoorDash, all of a sudden. DoorDash has a 15 close to a 15% take rate for their deliveries, but all in from a customer and restaurant perspective, it can be 30% of the order that goes to Fys. Toes just flipped that whole thing out of Ted. We think 80,000 customers or half of the toast restaurant base now has signed up for the toast ordering module, which effectively gives you free delivery in partnership with Uber Eats from the restaurant perspective. We always try to go out and do our homework on the ground. We ask the question of which restaurants would be likely to switch from toast to DoorDash if DoorDash were to offer POS for free even. There are a few things worth noting. One, the unit economics of switching from toast to DoorDash are non-rational. You're effectively saying you might save 50 bits on payments, which is not substantial, to go over to DoorDash where you're paying 13 to 15% take rate on deliveries. And that's a really meaningful difference. That take rate. You can actually do this, Matt. So if you go to your favorite local restaurant, decent chance now that they have toast deliveries and DoorDash deliveries enabled, pull up the delivery on DoorDash. You can get all the way to the order page of $40 delivery on DoorDash. We'll usually cost you something like 30 to $35 if you continue to the delivery page on toast. It's a really great offering. Restaurant customers love toast. Net promoter scores of 50 customer satisfaction rates of 95 plus percent. Those customer satisfaction rates are substantially higher than what we see in our surveys on DoorDash. The third thing is we We always put boots on the ground to test our howposses. So Mike. colleague actually went up to San Francisco the other day just this week and walked into 30 or 40 restaurants that have DoorDash and toast enabled bought something be a good customer. But ask them how likely would you be to switch from toast to DoorDash if it was free. We couldn't find a single customer that said they would switch if DoorDash offered free point of sale. We think both these companies can coexist and grow and be successful where I think DoorDash will find more success is in quick service restaurants that are delivery first restaurants versus where toast plays really well in the full service neighborhood restaurant. I can speak from personal experience, the frustrations that have existed from delivery fees from restaurants over the years are quite strong to invocal and it's just not something you hear as it relates to any other part of the business. I think that's out there. I respect the channel checks 101 boots on the ground that remains alive. That's incredibly interesting information to get back on that whole concept of switching and whether we call it churn. How much does the industry switch year to year? I almost put aside the fact that the restaurant industry sees a lot of turnover. We have a lot that goes out of business, a lot that comes into business. But do you have any concept on how sticky it is in just general churn? It's pretty well documented. The industry churns it's something like 15% a year. If you think about 800,000 restaurants in the US, something like 100 or 120,000 of them shut down and then generally restart every year. It's a tough business. What you see is that the business is really tough the first couple of years and then restaurants that survive for the first three to five years actually tend to survive for a very, very long time. The interesting thing from a churn perspective is that it's actually a huge positive for the challenger like toast. There's some industries out there with 99% retention. There's no churn and even if you have a better product, you come in with a hugely advantage product. Customers aren't going to churn and you're going to get 1% of the industry. You're going to get 1% at bat every year. You look at toast as the challenger, let's say 100,000 restaurants reopen or open every year. Toast is winning about 50% of those we think on a gross basis. They wouldn't get all those at bats if it was a higher retention industry. It's a strength for the challenger. I think the big debate or the big question is, so what happens in five years when toast is 30, 40% of the overall market? Do they look more like the market and does their churn go up? It's been a debate since 2020, 2019 as they get bigger. Surely their churn will go up. We haven't seen noticeable changes in churn. The reason for that, we think when we talk to customers, their businesses are so much more profitable using toast than they were otherwise that they just become healthier businesses that survive more. There's a big survivorship bias in the industry within toast customers. On the broader perspective of competitive advantage, modes, we talked a little bit about hardware, software, logistics. I guess just how would you frame it to the extent that we have mentioned a lot of varying things, but how would you package that together and just talk about their moat? There's been so much negative news on software in the last six months. We really wanted to simplify it and we always come back to what we call the laws of physics here at Counter-Global. Charlie Munger used to call him as mental models, but these are rules that have been durable for investing for decades and they hold true. We rely on those superpowers. We rely on those laws of physics. Toast is a mission-critical operating system. They have strong network effects. The industry is standardizing on this platform. They have huge data advantages. They have domain expertise. Speaking of Charlie Munger and his mental models, one of his actual mental models that he used to talk about a lot was that in any capitalist system, the specialist wins the outside share of the economics. He famously quoted that in a lot of his speeches. We believe in these laws of physics, these mental models. The interesting thing for toast is that it really checks all the boxes. The two structural modes that I think people don't talk about enough are hardware and how complicated it is for toast to deliver this great hardware. And then the distribution advantages they have. Starting with hardware, it took them many years to build, purpose-built hardware for the restaurant industry, but it's not just about the design. It's about the supply chain, the chips, making sure you have the right amount of inventory for your share gains. It's very, very complicated. And then the distribution is also really complicated. toast has feet on the street in every major city in America. And those advocates walk into restaurants all day long, talk to owners, make sure they're being served properly by toast. It's a huge part of the story that's really hard to replicate. I would just give you an example. A year or two ago, a high profile startup launched. It's supposed to be AI native serving the restaurant space. And I think they thought probably with AI coding and all the advances going on with AI that they could copy toast product and have something up and running pretty quickly. Fast forward to today, we aren't seeing them at all in the market. Last I heard they extended their roadmap. They think it's going to be at least another two years before they have something that looks like toast. And then at that point, good luck building the supply chain, good luck building the hardware. And then you've got to get feet on the street in every major city in America and abroad. I think it's just way harder to disrupt this space because the modes are so powerful. We haven't talked about the management team or just culture within the business. Tell me a little bit about who's behind it and anything that's unique about the culture to the extent there is something unique. It's a really phenomenal culture. The restaurant business has had a lot of ups and downs over the years. It's a culture of people who are really resilient. They put the customer first. So it's product led, it's resilient and it's customer first. And that's how I would describe their culture. From the top, it's a founder led team. It's a handful of really, really good people running this business. At Counter, we evaluate our management teams on three pillars. We talk about this a lot. It's integrity, ambition and innovation. So when you think about integrity first and you look at this management team, I'm on Durang and Elena Gomez. They're really great managers. They tell it like it is. They're super high integrity people and the people around them are super high integrity. On ambition, it's probably one of the more ambitious teams that we see in public markets. And they've been this way for many, many years. In 2020, I remember, I think they had 20 or 30,000 restaurants on the platform and they were talking about their path to 200,000 restaurants and then their path to 400,000 restaurants and everyone thought they were crazy. The Tam can't support that. You'll never innovate to open up new Tam's. It'll be really hard. Well, they're probably going to hit 200,000 restaurants this year or early next year. Now they're doing $2 billion a gross profit and they're talking about their path, the 10 billion of dollars of gross profit. And I think there's some skepticism out there. They have the track record of doing it. And so that gets to the third pillar we think about, which is innovation. This is the team you want in an AI world. There's three co-founders who met getting their computer science degrees at MIT. They really understand the technology. They really understand AI and I can tell you from spending time with them, they're more invigorated and more excited that I've ever seen about the opportunity because it allows them to accelerate the roadmap, open up new Tam's and just serve the customer in a way that wasn't really possible a few years ago. One net $10 billion gross profit milestone and how you think about Tam, what is the runway here? Where does it come from? Is it US based? Is it international? Talk a little bit about the path further out than the next three to five years maybe. From a big picture, just a review of the model and how the business model works because it's a beautiful compounder. The things that matter are location count, SaaS, RPU, payments, RPU, margins and multiple. If you look at the location count, if you double the location count and then you can also grow your RPU, you actually have the chance to 4x and then 8x the business over time. But we care a lot about the building blocks that get you there. That's how we need to underwrite it based on each specific Tam. The beauty of the Toe story is how they've sequenced their growth into new Tam's and opened up new Tam's over time. We talked about the core SMB as the primary driver of the business many years ago. At this point today, probably 150,000 of their 160,000 locations are in that core SMB US market and they're winning 50% of new restaurant openings. On a local level, I would say the trends are even more impressive. What you see when you go into the city level data is that they usually start with a 2% market share than maybe 4% the next year or 6% the year after. When a market hits 10% of market share, it becomes what management calls a flywheel market. That's when the network effects take hold and the market decides it will standardize on toast. you actually see market shares accelerate faster as they get bigger. We have data on some cities right now that are 25 to 30% market share and they're actually adding more market share in those cities than they are in the smaller cities. It's a great playbook. We think there's a long run way to go just in that core SMB and certainly management thinks so as well. The interesting thing from there is that they've already innovated and built the product for four or five new tams beyond that. And now they're actually in market and it's all about execution. They're in market with grocery store offering for grocery liquor and gas stations. That market primarily is served by legacy technology where toast has a huge right to win customers love the offering. We've talked to a lot of customers and we think there's a long runway there. They've started to win in hospitality. You saw big win with Mary. So they're winning hotel retail and F and B. That's a new offering in the last couple of years. Enterprise is really cooking nope unintended where they've won Apple bees and a handful of other really high profile enterprise customers that would have seemed impossible many years ago. So for people who thought that the tam for toast would top out at four five hundred thousand because they'll never get the enterprise. Now the tam in the US is actually bigger than the restaurant market. It's enterprise SMB plus grocery plus hospitality and then they quietly built an international business where they're in the market in UK, Ireland, Canada, Australia management would tell you that those markets are growing faster than toast grew in the US when they started here. I was in London last week seeing companies. You're seeing toast all over the place and I wasn't seeking them out. I was just walking into random restaurants and toast is all over the place. They're winning there. Big picture toast has a hundred sixty thousand locations on its platform today. Even if you take out China, they have a fifteen million location tam globally, most of which is served by legacy technology. So we think they're just scratching the surface and they have the opportunity to take themselves from two billion gross profit today to ten billion and twenty thirty five. But we actually just think that's a stopping point they can keep going from there. When you think about valuing a business with that type of grow runway and ambition, what's your general approach for valuation for this business? There are three ways that we look at valuation here. It all is in an effort to get back to intrinsic value. The first way you can look at it is on a multiple of twenty twenty seven gap earnings, which we talked about. It's trading at eighteen times twenty twenty seven gap earnings. That would be an even lower multiple if you want to adjust for the almost two billion dollars of cash they have on the balance sheet for a twenty five percent gross profit, rower and a thirty plus percent EPS compounder that screens tremendously cheap. More importantly, we think about intrinsic value and what kind of Moic we should expect or multiple uninvested capital over the next ten years because we have our tan build, we have our second build, we know the win rates and we think it's a highly predictable outcome from a business perspective. So over the next ten years, they're going to take gross profit we think from two billion to over ten billion. At that point, you'll be left with a business that's doing over three billion dollars of gap and that income and you will have generated your whole market cap and cash. So if you get a horrible multiple in twenty thirty five, you have something like a four X Moic and if you have a NASDAQ market multiple, you probably have something closer to a ten X Moic and then just on a DCF intrinsic value today, if you want to discount all the cash flows back, fair value today is something like fifty dollars per share or more versus the recent stock price at twenty two or twenty three dollars. No matter how we slice it near term long term, we're really excited to continue to be on this journey with toast and we think it's going to be a good outcome for investors. What are the risks besides the obvious execution and what stands out the most for you? There are three or four risks here that we think about and talk about and debate a lot. I mean, one is just macro exposure and you hit the nail in the head early in the call. How much of that fintech gross profit is really recurring and I think in this business in the restaurant business, it is a tough industry in some ways. In other ways, it's also a really great industry. It's a big market with a trillion dollars of volume every year. It does grow and in tough times, we've actually seen the restaurant industry is super resilient. So if you go back to 2008, 2009, I think the restaurant industry as a whole was down low single digits, one of the better performing industries in the economy because it turns out that no matter what's going on, people need to eat. Even in tough times, they want to go out and they want to eat and socialize with friends or family. The second thing we think about a lot, which we talked about today is industry churn and how that plays out for toast over time. We follow the data and so far what we've seen and what we believe will continue to see is industry leading gross retention for toast versus the competition, but it's certainly something we want to stay on top of. The third thing we think about is the price sensitivity of the customer base and how much RPU can you really squeeze out of the customer base over time. If this was a price game and we were betting on a lot of growth to come from pricing, we would be more concerned about this. What we've seen from the toast management team, which again is super innovative, thoughtful customer first, is that they're coming out with products that can be meaningfully high RPU for toast, but also a really good ROI for the customer. Toast grow marketing is the perfect example. $500 a month sounds like a lot when you're talking about a customer that probably has $150 or $200,000 a profit per year. But then if you put it in the context of raising revenue for your customer by $100,000 and replacing another cost bucket that they have where they're already spending $10,000, it actually becomes a no brainer and it's a win-win for toast and the customer. Then the last thing I saved it for last, but it's probably the risk that we stay on top of the closest is competition. We're always talking to customers. We're always serving customers. We go put feet on the street and boots on the ground to make sure that toast is winning in the wild, but it's something that we stay super close to. This has been timely and fascinating and toast is extended way further than I had imagined before researching the name. What stands out to you as a key lesson from this business that you could apply elsewhere? I've known the toast team a long time. The restaurant industry is really hard and toast has been through a lot over the years with COVID now the SaaS apocalypse. They always come out on top. Why is that? I was reflecting on why that is and what they've reinforced for me, I think, is a lesson of resilience. Work hard, expect the unexpected, put the customer first, learn from your mistakes, and I'll leave you with a pun. Stay hungry. I love it. Well, Sean, thank you again for coming on, sharing the knowledge, making it timely. This has been a true pleasure. Thanks so much, Pat. Awesome seeing you. To find more episodes of breakdowns ranging from Costco to Visa to Moderna or to sign up for our weekly summary, check out join Colossus.com. That's J-O-I-N-C-O-L-O-S-S-S-U-S.com. The information contained in this podcast is for educational and informational purposes only and does not constitute and should not be construed as an offer to sell or a solicitation of an offer to buy any securities or related financial instruments. All opinions expressed by hosts and podcast guests are solely their own opinions and should not be viewed as definite or exhaustive. 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