Laughing Water Capital recently released its Q3 2020 Investor Letter, a copy of which you can download here. The fund posted a return of 26.4% for the quarter (net of fees), outperforming their benchmark, the S&P 500 Index which returned 8.9% in the same quarter. You should check out Laughing Water Capital’s top 5 stock picks for investors to buy right now, which could be the biggest winners of this year.
In the said letter, Laughing Water Capital highlighted a few stocks and USA Technologies Inc (NYSE:USAT) is one of them. USA Technologies Inc (NYSE:USAT) offers consumer payment systems. Year-to-date, USA Technologies Inc (NYSE:USAT) stock gained 14.2% and on October 20th it had a closing price of $8.45. Here is what Laughing Water Capital said:
“USA Technologies (USAT) – USAT is the undisclosed top 5 position that I mentioned in the 1H’20 letter. I have included a full length writeup (that is now somewhat dated) under separate cover, but in brief, USAT provides end to end services including cashless payment services and enterprise software to the vending and other unattended retail space. The vending machine industry is not very sexy, but sales are generally recession resistant as if people are hungry or thirsty, they will still spend a buck or two on a snack or drink, regardless of the economy. USAT’s services are considered best in class, but historically the company had been poorly managed, most notably going through 5 CFOs in rapid succession, which led to accounting irregularities, an inability to promptly file financial statements with the SEC, and then a de-listing from the Nasdaq stock exchange. This very messy situation explains why the stock traded down from a high of more than $15 to below $4, as the delisting forced many owners to sell due to structural constraints.
From my perspective, while this history of mismanagement is scary, the competitive position of the company was largely unaffected by all of the drama. More importantly, a significantly more experienced and sophisticated team has come in and taken over the company following an activist battle. Combined with other insiders, the activist group – Hudson Executive Capital (HEC) – owns almost 20% of shares outstanding, and is led by Doug Braunstein, the former CFO of JP Morgan. Presumably this qualifies him to ensure that the company’s accounting functions are up to speed. Braunstein’s partner and now chairman of USAT is Douglas Bergeron, who is one of the most successful payments executives globally, having previously taken Verifone from an enterprise value of $50M to $5B. Additionally, HEC has installed Sean Feeney, a software savvy CEO known for his focus on company culture, to lead USAT going forward.
Feeney has made it clear that his focus will be on the company’s best in class SAAS offering and profitable growth, rather than growing payments connections regardless of profitability, as was the case with the prior team.
The simple changing of the guard has caused shares to re-rate higher, but in my view, considerable upside remains as Feeney and his team execute their plan. Importantly, there are several easily available levers to pull that will improve operating efficiency. For example, the company had previously been overly reliant on expensive consultants to help them manage their day to day affairs. With a more capable management team in charge, these consultants will be replaced by full time employees at a fraction of the cost of the consultants. These changes combined with the simple lapping of expenses tied to the accounting restatement and activist battle basically guarantee that a year from now the trailing GAAP financials will be significantly better than they are today, which when combined with an already improved balance sheet should attract attention from investors. If on top of these simple developments the team is able to execute as planned and grow their high margin SAAS business both domestically and abroad, USAT could be a contributor to our portfolio for years to come.
At this point, the full details of management’s plan have not been revealed as their first priority is rightfully establishing a firm foundation and level setting expectations after a period of extended mismanagement. From my perspective however, they are well positioned to follow the roadmap laid out by Savneet Singh at PAR Technologies (PAR), which remains a top 5 position for us. PAR is focused on restaurant POS software, but from a high level the similarities between the two investments are striking. Just like USAT, PAR was formerly mismanaged before pressure from activists led to Singh taking the reins, rebuilding the culture around ROIC, and emphasizing the company’s best in class software. To date the results have been a 4x in the stock price since Singh took over.
Similar to PAR, USAT has a clear opportunity to drive ARPU through additional functionality, and increase customer count through a best in class product and service. Interestingly, PAR just recently entered the payments space, where they are distinguishing themselves by being fully transparent with their customers, which is unusual in the payments world. USAT has an opportunity here as well.
My conversations with vending machine owners reveal that in most cases they don’t distinguish between how their spend with USAT is divvied up: they just know that they pay USAT $X per month. This is especially true among the smaller players that dominate the market with perhaps a few dozen machines. However, revenue mix is all important for USAT as I believe that revenue attached to payments comes with a single digit gross margin, while revenue attached to the company’s SAAS offerings comes with gross margins in the ~70% range, with incremental gross margins being higher still. It seems logical that USAT will attempt to shift their revenue mix toward software by offering improved payments terms as an inducement to customers to also use USAT software. For the customer, if a balance can be struck the bill will still be $X per month, but for USAT, the gross margin dollars should be multiples higher. Following this plan would of course introduce cannibalization risk with existing customers that already rely on USAT for payments and enterprise SAAS, although that risk would be mitigated if large customers are already receiving discounted terms on their payments, which I believe they are. Regardless, if some amount of cannibalization is the price to pay to gain high margin software revenue from the ~50% of USAT’s customer base that does not presently use their software, it will likely be worth it. If this plan works and USAT is granted a fast growing SAAS multiple by the markets, USAT has multi-bagger potential in the intermediate term, even before expanding horizontally by adding additional functionality to their software suite, executing on their plans to enter additional verticals, and expanding internationally.
This big picture strategy is well and good, but in the near term, special situation dynamics related to relisting to Nasdaq, and then being eligible for the forced buying that comes with index inclusion at the very least contributesto a margin of safety, and quite possibly will lead to shares appreciating significantly. As of now, the exact timing around relisting is uncertain. I do however find it curious that HEC recently launched a Special Purpose Acquisition Company (“SPAC”) that includes the former CEO and Chairman of Nasdaq as a director. Presumably this can only help grease the wheels for USAT’s re-listing.”
Our calculations showed that USA Technologies Inc (NYSE:USAT) isn’t ranked among the 30 most popular stocks among hedge funds.
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