Sizing Up Shift4 Payments (NYSE:FOUR)

Close up of young Asian man shopping at the flower shop. He is paying with his smartphone, scan and pay a bill on a card machine making a quick and easy contactless payment. NFC technology, tap and go concept

AsiaVision

“You cannot reason people out of a position that they did not reason themselves into.” – Ben Goldacre

This week’s deep dive is around an interesting fintech concern that has been pummeled by the market in 2022 like most of the sector. After losing two-thirds of its value, the stock has started to rebound and posted encouraging second quarter results last week. A full analysis follows below.

Stock Chart

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Company Overview:

Shift4 Payments, Inc. (NYSE:FOUR) is an Allentown, Pennsylvania-based provider of payment acceptance and processing, as well as related technology solutions in the U.S. The company’s platform is present in ~40% of restaurants and hotels domestically, boasting 425+ software integrations, over 7,000 distribution partners, as well as 185,000 small- and medium-sized businesses as customers. Shift4 was founded in 1999 as United Bank Card by then 16-year-old Jared Isaacman, converted to its current moniker in 2017, and went public in June 2020, raising net proceeds of $363.8 million at $23 per share. Its stock trades at just over $45.00 a share, translating to a market cap of approximately $3.6 billion.

The company is capitalized by three classes of stock. The 53.6 million shares of publicly traded Class A stock confer economic interest and one vote per share. The 26.3 million shares of privately held Class B stock bestows no economic interest and ten votes per share but have convertibility through the underlying Shift4 Payments LLC interests. The 4.3 million shares of privately held Class C stock bestows economic interest, ten votes per share, and convertibility.

Model & Organic Growth Strategy

Shift4 derives the majority of its topline from fees paid by its merchants using its end-to-end payments offering, which includes its payment acceptance platform, devices, POS software solutions, proprietary gateway integration (that connects merchant software to a payment processor – usually Shift4), and a suite of business intelligence tools. Generated as a percentage of dollar volume processed, end-to-end payments accounted for FY21 payment volume of $46.7 billion and revenue of ~$850 million, or 62% of the total. Other revenue is derived in the form of per transaction and monthly fees from merchants who subscribe only to the company’s gateway integration. Lastly, Shift4 generates monthly revenue from licensing subscriptions to its POS software, intelligence tools, and payment device management solutions.

Since 2019, the company has been driving organic revenue and gross profit growth by converting its gateway-only merchants into end-to-end customers who, once converted, tend to be sticky given the high switching costs. Management believes the typical conversion could result in a 4x to 5x increase in gross profit per merchant and will free up resources that are currently dedicated to connectivity with other processers (competitors). Shift4 has used a carrot approach with merchants during the pandemic but is positioned to force conversions through pricing and sunsetting some services beginning in 2H22. This ‘squeeze’ could result in the loss of some merchants but management estimates it as a $280 billion to $350 billion payment volume opportunity. This strategy, along with a focus on higher volume merchants – who are an excellent fit for Shift4’s highly integrated solutions – has resulted in the company growing its total end-to-end payments volume at a 37% CAGR from FY19 to FY21.

Furthermore, with recent customer wins, Shift4 is expanding beyond its niche in food & beverage and lodging, forging new alliances in other verticals, including healthcare (St. Jude Children’s Research Hospital), airline bookings (Allegiant – ALGT), and satellite broadband and internet providers (SpaceX (SPACE) Starlink).

Acquisitions

Beyond gateway conversions, management is employing proceeds from its IPO, debt financing, and its own public equity to grow through acquisition, making six purchases in the past two years. After acquiring a hospitality technology vendor for $9.9 million in October 2020, Shift4 bought ecommerce software platform 3dcart for $59.1 million in November 2020. To expand into the sporting arena and event complex vertical, the company purchased VenueNext for a total consideration of $72.0 million in March 2021.

Subsequent to buying point of sale (POS) systems company Postec for $14.3 million in September 2021, Shift4 purchased cryptocurrency donation marketplace The Giving Block as an entrée into the $470 billion (transactional volume) charitable non-profit vertical. The upfront consideration of $54.0 million paid to the acquiree can elevate by another $246.0 million based on the achievement of earnouts. That transaction closed on February 28, 2022 and was followed the next day by the announcement of Shift4’s acquisition of Finaro, a pan-European ecommerce platform accommodating over 170 payment methods that will accelerate the company’s growth internationally. To enter the European ecommerce processing market, Shift4 will pay an upfront consideration of $525.0 million, with additional earnout potential of $50.0 million. The Finaro deal is not expected to close until YE22. These acquisitions will transform Shift4 into a global payments platform with card-present, ecommerce, and crypto solutions for merchants.

Also through these acquisitions and organic vertical expansions, Shift4 has increased its payment volume total addressable market (sans yet-to-close Finaro) from ~$1.1 trillion to ~$4.2 trillion.

Stock Price Performance

Having gone public in the throes of the pandemic, Shift4 was rightly perceived as a beneficiary of the economy’s reopening and attendant multi-trillion dollar federal government assistance programs. As such, its FY21 revenue surged 84% over FY20 to $1.26 billion while its stock skyrocketed in anticipation of this growth by nearly 350% from its IPO pricing to an intraday all-time high of $103.37 in June 2021. At that moment, the market valued the company at 6.9x FY21 revenue and ~96x FY22E EPS, extremely generous valuations considering that its business (was and still) is driven by the relatively low-growth restaurants and hospitality verticals – its one-time gateway conversion strategy notwithstanding.

Priced for perfection, Shift4 stock began a death march to under $40 – punctuated by sharp counter-rallies like a 16% one-day spike in November on the back of its then-record 3Q21 earnings release and Investor Day presentation – over the subsequent eight months as the market came to the grips with inflation and dumped anything fintech. After another bear-market rally to north of $60 for part of March and April 2022, a Morgan Stanley downgrade on April 19, 2022 effectively resumed the backslide, which accelerated when Shift4 reported earnings on May 5th.

1Q22 Earnings & Outlook

The company announced 1Q22 earnings of $0.15 a share (non-GAAP) and Adj. EBITDA of $44.3 million on revenue of $401.9 million as compared to a loss of $0.20 a share (non-GAAP) and Adj. EBITDA of $22.2 million on revenue of $239.3 million in 1Q21, representing 100% and 68% increases at the EBITDA and top lines, respectively. Earnings beat the Street consensus by $0.09 a share while revenue was $18.3 million better than expectations.

First Quarter Highlights

May Company Presentation

Management reiterated its outlook for FY22, which included Adj. EBITDA of $245 million from gross revenue less network fees (a gross profit-like metric) of $690 million on revenue of $1.95 billion generated from $79 billion in end-to-end payment volume. All projections based on range midpoints.

Additionally, led by the gateway conversion strategy, management expected the following run rates by YE24: end-to-end volume of $160 billion; gross revenue of $3.5 billion; and gross revenue less network fees of $1.15 billion. The end-to-end volume estimate represents a CAGR from FY21 to YE24 of ~48%.

Despite the solid report, shares of FOUR fell 14% in the subsequent trading session to $45.45 and then continued their decline down to the low $30s before the recent rally.

Second Quarter Results:

The stock got a boost in the arm last week when the company reported second quarter numbers. Easily besting expectations, non-GAAP earnings came in at 33 cents a share. Revenues rose nearly 45% on a year-over-basis to $506.7 million, some $30 million above the consensus.

Second Quarter Highlights

August Company Presentation

Management provided the following FY2022 guidance as part of its earnings release. These included payment volume of $68 billion to $70 billion and adjusted EBITDA of $255 million to $265 million. Total fiscal year revenue is projected to be in the $1.9 billion to $2 billion range. It was more than a solid quarter as evidenced by the data points above.

Forward Guidance

August Company Presentation

Balance Sheet & Analyst Commentary:

As of the end of the second quarter, the company had just over $1 billion of cash and marketable securities on the balance sheet against just north of $1.7 billion of long-term debt. Adjusted free cash flow is expected to check in at $100 million for FY2022.

Balance Sheet

August Company Presentation

With the stock in decline back in December 2021, Shift4’s board authorized a $100 million share repurchase program. Unfortunately, for Shift4, it essentially burnt through that authorization by the end of April 2022, purchasing over 1.8 million shares at an average price in the mid-$50 area. Already down ~$20 a share on its first $100 million of buybacks, the board authorized another $50 million of repurchases on June 16th.

Over one out of every five shares outstanding are currently held short. The CEO bought just over $10 million worth of shares via several transactions in March and one in June. The shares have seen no insider selling so far in 2022.

Five analyst firms including Credit Suisse and RBC Capital have reissued Buy or Outperform ratings on FOUR since second quarter results hit the wires last week. Four of these had upward price target revisions. Price targets proffered range from $55 to $65 a share.

Verdict:

The current analyst consensus has the company earning just less than $1.10 a share in FY2022 as revenues rise some 40% to some $2 billion. For FY2023, sales are expected to rise just over 35% as the company delivers $1.85 a share in profits.

The company showed considerable progress since it posted first quarter results. Better-than-expected second quarter numbers have moved the stock nicely higher. However, at over 40 times forward earnings, I don’t think I would be chasing this rally given my negative view on the overall market. If the stock dropped to around $37 a share (20x’s Y2023’s profit projections) in the next pullback in the market, I would probably initiate a starter position in the shares at that time given the company’s impressive growth.

“People are generally better persuaded by the reasons which they have themselves discovered than by those which have come into the mind of others.” – Blaise Pascal

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