The Bull/Bear Battle Over USA Technologies Intensifies – USA Technologies, Inc. (NASDAQ:USAT)

Over the past few weeks, Seeking Alpha has been home to a bull/bear debate regarding USA Technologies (USAT). Both sides (including yours truly) have made their points, so I won’t rehash my original thesis here. After all, you don’t make money on stocks by the effort you put into a debate – you make it by being on the right side of the story.

In that regard, time will be the judge.

In the meantime, all sides are subject to personal biases. Donald Marchiony, a promising young analyst, has dug into the numbers and interpreted them as painting a compelling short thesis. He was long, but professed to have grown frustrated waiting for progress. Now, with progress being made, Mr. Marchiony is upping the ante on his short call.

I am also biased, but bullish. Maybe this is because my story is the opposite of Mr. Marchiony’s. I’ve watched this company from the sidelines for years… and only now do I see something exciting. I think the shorts are going to get squeezed, helping the shares rise 50% to their fair value.

Specifically, I’m predisposed to stories which involve large installed bases that can be monetized via M&A-based and organic product development. USAT fits the description. Historically, companies like this either figure out how to win on their own or get acquired by a company that can.

It’s a good formula, but fails when an inept management team drives the company into the ground before accepting an attractive M&A offer. That seems to be what the bears expect, but it’s hard to go under when you’re growing your top and bottom line.

Speaking of which, all management teams are inherently biased. However, that doesn’t make them right (or wrong). However, over the past two years, insiders have exclusively bought shares – no selling.

Both sides seem to agree that management is telling a good “story” — we just disagree on whether the story is true or not. Management will be sharing that story with investors next week. CEO Stephen P. Herbert and CFO Priyanka Singh will present at the 6th Annual Liolios Gateway Conference on September 7 at 5:30PM Eastern Time in San Francisco. The presentation will be webcast and recorded at USA Technologies website and on the Gateway Conference website.

The final player in the debate is Wall Street. Prior to today’s bear raid, William Blair’s initiation report was the most-recent data point on USAT. We all know that Wall Street is biased. However, William Blair is a solid firm with a reputable long-term track record. Just last year, I doubled my money on Radcom (RDCM) after participating in its secondary — through William Blair.

William Blair Asset Management also has its money where its mouth is. They own 4.4% of USAT and have been shareholders for over 18 months.

The takeaway is this – everyone is biased and everyone has made their points about why USAT should go up (or down) in value. As an investor, you have to decide which side is right. In “battleground” stocks like USAT, big profits often go to the winners.

In that regard, I offer rebuttals of some key points made in Mr. Marchiony’s latest missive:

Point #1 – Mr. Marchiony says that “Fiscal 2018 Adjusted EBITDA growth guidance is extremely misleading when taking the recent 20%+ equity dilution into account.”

The company just attracted tens of millions of dollars of investment capital from professional investors. Undoubtedly, that is going to dilute per-share guidance. Larger denominators have a tendency of doing that. It doesn’t mean that we can all get rich by shorting stocks that do a secondaries. As mentioned above, the story of Radcom and others, expose that as flawed logic.

Interestingly, bears have also jumped to the conclusion that USAT is raising equity to cash out. To me, this doesn’t make sense. Insiders have been buyers, not sellers… so why would they “dilute” themselves with this offering?

The answer is simple.

USAT’s secondary offering gives them the firepower to leverage its installed base in a manner that will increase this market’s barriers to entry. That is the best way to flourish in an otherwise commoditized market.

Point #2 – The bears have completely ignored the implications of USAT’s January 2016 acquisition of VendScreen (for $5.6 million).

VendScreen was venture-backed with $64.5M of investment. This sweat equity (potentially representing 25% of USAT’s entire market cap) accrued to the company because neither VendScreen (now called ePort Interactive), nor most any other suitor, had the installed base to leverage VendScreen’s capabilities.

That leverage is powerful. VendScreen has reported that its technology has resulted in 85% sales increases, delivering a nine-month ROI for customers. Thus, it should come as no surprise that ePort Interactive (VendScreen’s new name, under USAT’s umbrella) has emerging as a boon to USAT’s financials.

In other words, investing for growth is unlocking opportunities that smaller competitors can’t take advantage of.

VendScreen added cloud-based interactive media and content delivery capabilities. Meanwhile, it’s vending management software (VMS) partnership with GimmeVending was only announced in April 2017, demonstrating that VMS is still in its early innings.

Bears need to ask themselves why the bulls call the software market untapped, despite acknowledging how long software has been available in the market.

The answer is simple. In the technology market, it’s a big mistake to confuse time with maturity. For example, HR software had already been around for decades when Workday (WDAY) appeared on the scene.

I’m not comparing USAT to WDAY, but there is a similarity in that software constantly evolves, creating ever-evolving opportunities (and threats) for the vendors involved. The big money is made by identifying inflection points in that evolution.

In this case, forward-looking analysts believe that the rise of cashless payments is sparking an inflection point for USAT. There are an estimated 30 million vending machines worldwide. Less than a third of machines in the U.S. currently accept cashless payments. This will undoubtedly move to 100% in time.

So USAT has at least 20 million potential connections to go after. So far, they’ve built a $100 million revenue company (and a $200M+ stock that has risen very nicely since 2010) by attracting just over 500,000 connections. That’s just 2.5% penetration!

In other words, this market is still in its infancy.

The Internet of Things is just starting to emerge and vending machines are among the most intuitive “things” to benefit from fully-leveraging the power of the Internet and Cloud computing.

A rising tide floats all boats. USAT has stayed nicely afloat on its own, so what will happen when it catches this wave? The bears believe that USAT needs a life raft. However, the company has shown no definitive signs of sinking.

Point #3 – The bears believe that the delayed monetization of USAT’s installed base equates to failure of the strategy.

It’s 100% true that management has been talking about monetizing its installed based for a long time. This is why bears argue that they’ve sacrificed margins for future profitability for too long.

But tell that to Jeff Bezos.

USAT will never be compared to Amazon (AMZN), but the stories have one thing in common. Plans need to be changed as market dynamics change. As Bezos has identified new opportunities, he has repeatedly delayed AMZN’s move to ramp profits meaningfully.

Every step of the way, bears have growled about Amazon’s lack of margins and profitability. In fact, AMZN is very profitable… they just happen to be reinvesting those profits into new artillery to take over the world.

This is often a point of bull/bear debate. The question is whether management is prudently responding to changing market dynamics or simply using that as an excuse for kicking the can down the road. In the case of USAT, bears believe it is the latter. However, based on my assessment of the market and USAT’s current market penetration, I strongly disagree.

So, while USAT can never truly be compared to AMZN, the stories have similarities. I think investors will also be shocked to see that USAT’s stock has performed just as well as AMZN’s, dating back to 2010:

Source: FreeStockCharts.com

This doesn’t mean that the bears are wrong. However, it does illustrate that investors have been growing increasingly bullish. We bulls understand exactly what the bears are saying… we simply disagree that it’s a bad thing!

Point #4 – The bears have been focused on backward-looking metrics and facts.

The bears can spin past financials any way they want, but the company just reported a great year of progress and provided equally-strong guidance. The bears aren’t claiming that USAT is a fraud. They simply aren’t comfortable with the idea of sacrificing margins to obtain top line growth.

Investors who have put time into understanding the forward-looking direction of this market are perfectly comfortable with management’s decision to delay improvements to its profitability.

This is because large vending machine operators are just starting to embrace the notion that vending machines are prime to benefit from the Internet of Things.

Just recently, USAT signed a five-year deal with Five Star Food Service for 9,000 ePort Interactive devices. For those who are wondering, Five Star is a part of one of the larger vending machine organizations in the world. If this deal delivers anything close to the aforementioned nine-month ROI, 9,000 devices will only prove to be the first drop in a large bucket.

Point #5 – Marchiony also stated that, “Despite years of promises of profitability inflection points, and a 32% increase in connections during F2017, free cash flow burn was $10.8M during F2017, the highest burn since F2010.”

This statement completely ignores that connection growth is actually accelerating (50K net new connections in FY13, followed by 52K in FY14, 67K in 2015, and 96K in FY16 and 136K in FY17). It’s not unusual for accelerating growth to result a higher cash burn. If you could derive $10 of annual profit by spending $50 upfront to acquire the customer, you’d take as many losses as you could fund until customer acquisition costs became unfavorable relative to the ROI.

USAT is far from that point, which is why they’ve been stepping on the accelerator.

This is evident if you acknowledge that the margin contraction is taking place in equipment while L&T margins expand. Furthermore, USAT has significant runway to add more and more products to its arsenal. Thus, it only makes sense for them to reinvest their profits to acquire more and more customers. They are not surprising anyone with this — they beat revenue and EBITDA guidance in the latest quarter… and it’s the 3rd quarter that USAT has beat consensus EBITDA. In other words, EBITDA is not even tanking while growth accelerates!

To the contrary, after several years of compression, adjusted EBITDA bottomed in fiscal 2017.

The bears have yet to acknowledge this, nor the implications of the trend turning positive. Even modest margin expansion will lead to strong bottom line growth (every 100 basis points of improvement adds $0.03 of EPS) when coupled with strong organic (and inorganic) revenue growth.

Bears just keep complaining about USAT’s low margins… but I’m all for it. Low margins aren’t great for USAT’s current EPS, but margins this low spells death for smaller players. They will choke under the pressure. Of equal importance, new competition will not step in to take their place. When the smoke clears, USAT will have more market share, less competition, and stronger barriers to entry.

The bears think it’s important that much of the hardware in the market is comparable. If that’s the case, the bears should only invest in monopolies. Competition is a part of any market… but in this market, very few have achieved as much success and scale as USAT.

As the market continues to progress, economic advantages (and attractiveness for being acquired) will accrue to the players with a proven ability to scale.

It’s a battle of attrition – a marathon, not a sprint. USAT’s growth rate and stabilizing margins show that they are winning the race.

In fact, USAT’s customer base has more than doubled in recent years. Of equal importance, those customers stick with USAT. Attrition is estimated to be less than 1% per quarter.

The bears frequently remind us that it’s easy for USAT customers to switch vendors… but they don’t! You can’t underpin a bear thesis with the hope that a long-standing dynamic changes.

The bears also claim that some of that growth has come from changes that impact revenue recognition. I agree with the word “some”, but that’s not enough to explain why USAT is growing so much faster than the market (remember, we’re talking about vending machines, folks). If anything, those changes in rev rec are going to help USAT make their numbers for the next few quarters. That buys the bulls time to decide if things are proceeding well or not. For the bears, beat-and-raise quarters will inflict losses long before they have a chance to be proven right. If things start to look the bears’ way, I can always sell at a profit, sell short, and make money coming and going (meanwhile, the bears will be holding a long time just to break even).

There’s nothing wrong with avoiding situations like this. Just understand that situations like this are exactly how technology companies win in the modern era. Grab the most share, lock the competition out, lock the customers in, and then reap the benefits.

The bears can’t argue about USAT’s growth. They simply don’t like the wait.

I can’t say that I blame them, but it’s not my fault that they were too early to the story. These things take time and you have to pick the right moment to get involved. Personally, I think we’ve seen the bottom in margins and that’s why I’ve chosen now (as opposed to the past several years) to invest in USAT.

Point #6 – The bears point to its bottom line to justify claims that the stock should drop 50%.

By that logic, AMZN’s stock would have dropped 50% about 800 points ago. The same goes for any company that is investing for growth. For many successful growth companies, the bottom line simply comes later.

This is why institutions are more focused on top-line growth when calculating fair value. From that perspective, USAT is selling for 1.6x calendar 2018 revenue estimates. This is a significant discount to its peer group.

If USAT was not showing 20%+ annual growth, I would be in 100% agreement with the bears. However, the bears fail to assess how much USAT’s bottom line would benefit if they stopped pouring more (and more) money into sales people, marketing, and R&D.

Conclusions: This article will surely not the last on this subject. The “debate” will rage on. However, moreso than a debate, I just a difference of opinions.

I acknowledge many (but certainly not all) of the backward-looking financial points that have been raised by the bears. However, in my opinion, they have overplayed their hand with several of their financial conclusions. They have similarly failed to adequately address the more important issue, which is… where is USAT going in the future.

The point raised by the bears are not a revelation to the bulls. Top line growth without bottom line growth is indicative of a company which has favored top-line growth over profitability. The bears don’t like it because it can also be indicative of a company stuck in an unprofitable industry.

However, Wall Street has been voting with its wallet. In addition to increased insider ownership, institutional ownership has also been on the rise:


Source: NASDAQ.com

Thus, the “debate” comes down to whether you believe that USAT’s growing installed base will eventually afford them the economies of scale needed to grow its margins and accelerate bottom-line growth.

In my opinion, the bears are paying too much attention to the fact that the environment is competitive and not enough attention to what it’s doing to the smaller vendors in this space (nor what that means for USAT’s future).

It all comes down to this — USAT is bigger and growing faster than most of the competition. The company has simultaneously armed itself for an acquisition spree.

That doesn’t sound like a company on its heels.

It sounds like a company on the attack.

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Disclosure: I am/we are long USAT, USATP.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The information in this article is for informational and illustrative purposes only and should not be regarded as investment advice or as a recommendation regarding any particular security or course of action. The opinions expressed in Pipeline Data, LLC publications are the opinions of Mr. Gomes as of the date of publication, and are subject to change without notice and may not be updated. This content may also be published at PipelineDataLLC.com at a prior or later date. All investments carry the risk of loss and the investment strategies discussed by Mr. Gomes entail a high level of risk. Any person considering an investment should perform their own research and consult with an investment professional. Additional trading disclosures can be found in the Important Disclosures section at PipelineDataLLC.com.

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