Shift4 Payments: Getting Acquisition-Driven Growth (NYSE:FOUR)

Shift4 Payments (NYSE: FOUR) offers POS or point of sale solutions that help businesses accept payments. Mainly serving restaurants, hotels and stadiums, it boasts double-digit revenue growth, while its forward price-to-sales ratio trades at a significant reduction.

Also, with the Federal Reserve increasingly likely to turn dovish later this month, stocks could reverse the downside suffered when interest rates were hiked aggressively from March 2022, as seen above.

Furthermore, based on its recent acquisitions, this thesis aims to show that this is an investment opportunity, but it is also important to highlight the risks posed by high debt and operating expenses and how they are being addressed. I begin by providing information about increasing income.

Acquisition-driven growth strategy

This company has grown strongly over the past five years as per the chart below, and this is largely explained by twelve 2018 acquisitions covering both North America and Europe. With an average of 2 acquisitions annually over the past three years, growth has increased to over 75% for FY-21. Going forward, the three companies it acquired in 2024 should provide a boost 28.65% growth recorded for FY-23.

Thus, in June it acquired a majority stake in Vectron, giving it approximately 65,000 POS customers in Europe, covering the hospitality industry (including restaurants). Equally important, the deal includes the regional distribution network of around 300 resellers and a volume opportunity of around €25 billion or $27.7 billion. It previously acquired Revel Systems with 18,000 merchant locations for a payout opportunity of approximately $17 billion. Therefore, the total payment opportunities amount to $44.7 billion and assuming it manages to capture only 50% of them, it comes to $22.35 billion as shown below.

Now, a payment processor normally charges between 0.15% and 0.35% for each transaction that goes through the POS, and I assume an average of 0.25% for Shift4. Applying this multiplier to $22.35 billion in sales, I get $558.75 million. Then, dividing that figure by FY-23 revenue of $2,564.8 million, we get 21.79% representing the year-over-year sales growth for FY-24 due to these two acquisitions. This in turn lowers the forward-sales price from 1.45x to 1.13x and on the upside leads to a target of $92.56 based on the current share price of $76.

Now, in both cases, the deals are expected to close this year itself, meaning the above acquisition revenue would add to the analyst consensus estimate of $3.56 billion for FY-24, which may leading to a 60.23% YoY increase to $4.12. billion (3.56 + 0.55875) instead of the expected 38.44%.

Additionally, recent acquisition opportunities appear not to have been captured in the FY-24 topline, which was revised lower from the $3.77 billion expected in February. Similarly, while there has been upside from buying, the market still appears to have undervalued the opportunities as the forward P/S remains underpriced relative to financials by 49%.

There can be two reasons for this.

Competition and risks related to acquisition-driven growth

First, it remains a highly competitive industry, with many big players like PayPal (PYPL) and Block (SQ) endowed with vast financial resources, not to mention brand recognition. Looking ahead, there are Stripe and Adyen who have quickly built strong positions in the Fintech industry, which may limit Shift4’s ability to grow market share. This space has also seen continuous disruption and the emergence of new entrants that can force existing players to lower prices (commission fees), impacting margins.

Second, there’s its exposure to retail and hospitality, which could be hit by cautious consumer discretionary spending, according to a McKinsey report, despite continued optimism in the US economy. To that effect, Shift4 management acknowledged that “the good times are over” during its Q2 2024 (Q2) earnings call. Drilling deeper, the good times can be linked to the boom in consumer discretionary spending, particularly for restaurants, following the lifting of COVID-19-induced social distancing measures. This partly explains why it rose 78% year-over-year in fiscal 2021.

However, since then its business mix has diversified considerably and is now more inclined towards sectors such as hotels and stadiums, but this change may not have been appreciated by the market, which could explain its lower valuations. This becomes apparent when compared to Toast (TOST), a larger restaurant-focused payments processor whose trailing P/S of 2.99x trades at a 77% premium to Shift4 despite rising revenue the latter by only 12.5%, as shown. below.

This reinforces the idea that the market may not have rewarded Shift4 for diversifying its growth drivers, which may also mitigate the effect of deteriorating macros that could affect demand for payment processing services.

However, the way it allocates capital to support its inorganic growth initiatives has increased its debt levels, as shown in the chart below. It also paid $32.1 million in interest expense in the last fiscal year, meaning that as a rate-sensitive stock it can be hit by volatility if the Federal Reserve doesn’t pivot as expected.

In addition, profitability may also be affected by general and administrative expenses up 30.6% from last year due to the impact of acquisitions, with the company’s gross profit margin remaining below the financial sector median. Also, despite relatively high cash flow from operations, FCF’s margins remain lower than its peers due to its aggressive acquisition strategy that requires large capital infusions, which has resulted in debt accumulation of 1 .79 billion USD at the end of Q2.

This is why it is important to dig deeper into the operating model.

Looking deeper into the operating model

As such, it not only acquires companies to expand its customer base and graphical presence, but also to diversify its product offerings, as illustrated by its recent acquisition of Givex (OTCQX:GIVXF) for $148 million . Now, given that Givex is also a gift card and loyalty program provider in addition to POS, the intent here appears to be more towards enhancing capabilities in integrated solutions through which the Shift4 platform can offer more bundled product offerings, including gifts and loyalty programs.

In this way, it improves competitiveness by enhancing the payment platform with new capabilities to meet new market demands.

Just as importantly, as the installed base grows, cross-selling opportunities abound, allowing it to drive SkyTab mobile, a pay-at-the-table solution that enhances the experience of restaurant customers and servers as it integrates with the system Company POS. For investors, SkyTab growth continued to accelerate with nearly 10,500 system installs in Q2, or 12% sequential growth.

Thus, by providing an integrated solution across the stadium, restaurant, hospitality and retail sectors, revenue streams can be diversified beyond payment processing as Shift4 becomes more vertically integrated.

Obviously, a larger installed base can generate operational synergies that result in higher cash flow generation, which has been the case over the past five years, as outlined below. Also, while debt grew, EBITDA grew at a faster pace, resulting in net leverage of 2.7x at the end of the second quarter.

Thus, as a counterbalance to its growing debt, essential to finance its acquisitions, Shift4 generated more EBITDA and cash from operations. In addition, the fact that interest expenses were slightly lower, in stark contrast to the increase in debt (as per the chart above) tends to point to tight debt management involving refinancing at lower rates.

Therefore, while Shift4 has not gone down and has more debt as equity than Toast, it has maintained its creditworthiness, essential for allocating capital for potential investments and growth in a way that mitigates the effects of economic downturns. Along the same lines, to support its value, it plans to continue buying back its shares and plans to buy back shares worth $500 million by December 2025.

A buy after considering the risks

In conclusion, this thesis is bullish on Shift4 based on the potential for inorganic growth following two acquisitions this year and the higher volume of transactions to be processed. Thus, an upside of about 22% is estimated to a share price of $92.56, which may appear on the upper side, but still, the opportunities for the third acquisition (Givex) have not been taken into account, and the increase of 22% remains well below the degree to which it is undervalued in relation to the sector or 49%.

Moreover, its debt has increased, but it has managed to maintain its financial health, continuing to expand both EBITDA (operating earnings) and cash flow from operations at an even faster pace. This can be helped by a more accommodative Fed, which boosts economic growth by reducing borrowing costs, resulting in even more refinancing options for Shift4. To this end, there is a strong commitment to a disciplined approach to cost management.

Turning to valuations, EV/EBITDA (which takes into account market cap and debt minus cash) and price-to-cash flow multiples trading at a significant premium of more than 40% to the sector median, as shown below, tend to indicate market optimism about future returns. So, on a note of caution, the risk is that the stock could be punished if it can’t turn additional sales opportunities into profitability and cash flow quickly enough.

So a lot will depend on execution, and to that end, the press release for the Vectron acquisition mentions that prior to the acquisition, there was minimal monetization of payments, implying that Shift4 will completely overhaul (explode) the revenue model under the M&A . formula to pivot the business to more payment processing and SaaS (subscription sales). Finally, cost synergies can be generated by promoting better customer engagement while promoting more integrated payment solutions and providing value-added services including analytics and reporting.