NCR CORP NCR
November 30, 2020 - 9:41am EST by
Saltaire
2020 2021
Price: 28.63 EPS 0 0
Shares Out. (in M): 133 P/E 0 0
Market Cap (in $M): 3,802 P/FCF 0 0
Net Debt (in $M): 4,301 EBIT 0 0
TEV ($): 8,103 TEV/EBIT 8 0

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Description

NCR – Investment Thesis

November 2020

All figures presented in US$ millions, except for per share data.

All share price data as of market close, 11/25/20.

Situation:

NCR Corporation (“NCR” or the “Company”) operates across three verticals: Banking, Retail and Hospitality.  In each vertical, the Company offers hardware products (ATMs, self-checkout and point-of-sale devices) and associated software and services.  The Company is targeting a shift in its mix of software and services from 65% today to 80% of which 45% is currently recurring, with a target of 60%, in the coming years.[1]

At <8x EBITDA, NCR is being valued as a slow-growth, ATM hardware business.  Investor focus on declining cash usage is obfuscating NCR’s leading share position in every segment in which it competes, multiple vectors to drive growth and unlock value, and attractive FCF characteristics that make the Company an ideal private equity target.  

We recommend NCR as a long with a target price of $40.00 (+40% upside).

Segment and Industry Overviews:

Banking (Revenue: $3.6bn / 51% of total; EBITDA: $550mm / 53% of total)

Following years of tighter regulatory requirements, slow macro trends and increasing competition, banks are under pressure to optimize customer acquisition strategies and lower operating costs.  The response has been an overhaul of legacy IT infrastructure to automate and outsource more processes.  The more engagement a bank can drive through ATMs and digital products, the higher the cost savings through reductions in tellers and branches.  Consumer preferences also increasingly demand a streamlined end-user experience across ATM machines, bank tellers, digital offerings and support centers. 

This “branch transformation” process is a lengthy and ongoing undertaking.  Simply managing an ATM requires at the minimum: software distribution, machine monitoring and reporting, cash handling, and machine management.  Banks have historically managed these functions using various providers, applications, and manual processes, which has resulted in a messy, costly patchwork of solutions.[2]

Bank Branch Channel Software Ecosystem (2)

NCR offers financial institutions ATM hardware units, ATM software applications, consumer-facing digital banking applications, ATM break/fix servicing, and professional consulting services.

ATM Hardware (Revenue: >$1bn / 18% of total; EBITDA breakeven)

NCR’s ATM hardware units span from simple cash dispensers to interactive teller machines.  The vast majority of ATMs sold are replacement or upgraded units.  NCR has historically sold ATM hardware units at a loss, but following recent cost structure initiatives, the hardware is now approaching breakeven.

NCR principally competes in the mid-to-high end, $40-$60k ATM units.  “Branch transformation” is driving the need for higher-functioning ATMs, which carry ASPs at the high-end of this range.  Higher-end ATMs offer services which would otherwise require a branch teller, such as cash dispensing, check depositing, cash recycling and interactive/assisted services.

The pullback of discretionary capital spend at financial institutions this year, along with lapping an associated Microsoft operating system upgrade, has been a headwind for ATM hardware, as revenues decreased from $1.25bn in 2019 to $1bn LTM 9/30/20.  Management has guided to $220-$250mm of hardware revenue per quarter for the next few quarters and has optimized its cost structure accordingly.[3]

NCR’s primary competitor in ATM hardware is Diebold.  Hyosung is also a sizable competitor, but primarily focused on Asia.  

Though NCR’s strategy is to sell hardware at breakeven and make money on software and services, our channel checks suggest that roughly 30% of ATM sales are hardware-only sales, primarily in Asia where financial institutions are largely state-run and install their own proprietary software, network and payment processing solutions.  

Banking Software (Revenue: $1bn / 15% of total; EBITDA: $360mm / 35% of total) and Services (Revenue: $1.3bn / 18% of total; EBITDA: $190mm / 18% of total)

NCR offers a range of software applications and services for ATM hardware units – both NCR and non-NCR devices.  The vast majority of NCR ATM units are bundled with recurring (3-5 year contracts), high-margin software license and maintenance revenue, in addition to a hardware maintenance contract.

NCR holds the #1 position in ATM software (~40% share)[4] and a sizable portion of the ATMs it services are non-NCR ATMs.[5] 

Below are the economics of a new ATM hardware unit sold.  Attached with every $100 of ATM hardware revenue is $11.50 in recurring software license and maintenance revenue at a 90% GM and $15 in recurring hardware maintenance revenue at a 30% GM.

 

Year 1:

 

Revenue

GM

GP $

ATM Hardware

 

$100.0

0.0%

$0.0

Software License

 

10.0

90.0%

9.0

Software Maintenance

1.5

90.0%

1.4

Hardware Maintenance

15.0

30.0%

4.5

Total

 

$126.5

11.7%

$14.9

         

Year 2 and beyond:

     

Software License

 

$10.0

90.0%

9.0

Software Maintenance

1.5

90.0%

1.4

Hardware Maintenance

15.0

30.0%

4.5

Total

 

$26.5

56.0%

$14.9

 

 

This “ATM-as-a-service” solution is highly compelling from the customer’s perspective.  Instead of a large initial capital outlay, recurring monthly payments cover the hardware, installation, maintenance, operational support, software & security management and cash management.  Having NCR manage the entire platform enables a high-level of integration and is particularly additive for tier 2-4 banks, where much of their customer interaction spans disparate applications and is siloed across various touchpoints.

Software applications include payment processing software, fraud and loss prevention applications, cash management, and video banking software.  The shift to higher-functioning ATMs also drives incremental software revenue (given additional services such as multi-language / multi-currency functionality).

Of NCR’s $1bn in Banking software revenue, $400mm is related to NCR’s Digital Banking platform, and $200mm is related to unattached software such as security fraud, transaction processing, and other professional services.[6]

The Company provides ATM break/fix services, which is a $1.3bn revenue business and covers everything from basic repair resolutions to full networked managed services and outsourcing.  Approximately 80% of Services revenue consists of multi-year contracts and management has cited industry-leading contract renewal rates. 

NCR also works with financial institution customers to provide a range of professional / consulting services.  For instance, when the UK £20 note was being replaced, work was required in coordinating with central banks, adjusting the note algorithms on the ATM and acquiring regulatory certifications.  NCR was engaged to manage this process.

Digital Banking (Revenue: $400mm / 6% of total; EBITDA: $140mm / 13% of total)

NCR offers cloud-based digital banking consumer applications that can be bank-branded and used as the primary interface for online banking with capabilities such as money transfers, virtual check deposits, and support access.

The Company reaches 24mm end users across its two Digital Banking products, Digital Insight and D3.[7]  Digital Insight is targeted at North America based community banks with under $20bn in assets.  The D3 product was acquired in 2019 and extends the Company’s reach to large domestic banks and international banking customers. 

50% of the Company’s Banking customers have adopted Digital Banking products.  NCR receives an initial fee based on the bank’s assets and number of customers, followed by recurring variable fees tied to monthly active users.  NCR is also able to upcharge based on additional features introduced.  

Our channel checks suggest significant white space exists with community banks and credit unions, which are generally reluctant or unable to deploy the capital required to develop, distribute and maintain a proprietary digital banking application, but whose customers are increasingly demanding digital banking services.

The market is highly fragmented and lacking market share data.  Competitors include FIS, Jack Henry, Q2, Alkami, Temenos (fka Kony).

Retail (Revenue: $2.2bn / 32% of total; EBITDA: $330mm / 32% of total)

NCR offers self-checkout systems (“SCO”) and point-of-sale hardware (“POS”), along with associated software for retail enterprise POS, digital marketing, loyalty programs, inventory management and connected payments.

NCR holds a 60-70% share in SCO hardware.  Customers include major retailers, grocers and gas stations.

Retailers are undergoing a significant digital transformation.  An example is Amazon Go.  NCR has invested in similar technologies and today can facilitate a customer’s ability to walk into a store, grab a product and walk out while being automatically identified and charged.

 

 

 

The Evolution of Retail Stores

Source: RBC research.

The Company’s retail software offering, Emerald, is core to retailers’ digital strategy and includes capabilities such as the ability to order online, pick up in store, have cameras on the SCOs monitor for theft, deploy AI to determine exactly what products are being placed in basket, etc.

Covid has accelerated digital transformation initiatives for retailers, as self-checkout systems and curbside pickup options – which NCR enables – become more relevant to omni-channel strategies.  As an example, Walmart recently engaged NCR to develop a tap-and-go payment solution.  NCR was able to deliver a product within 72 hours and is now embedded in the Walmart Pay app.

We believe NCR’s incumbency with retailers matched with industry-leading software suites perfectly positions the Company to capitalize on the transformation.  Numerous customers including Walmart, Home Depot and Target have announced digital transformations, which NCR will be participating in.

Beyond the high-demand for NCR’s SCO devices, the opportunity in software and services expands to the entire retail infrastructure and digital offering.  As an example, NCR software powers Walmart’s entire IoT strategy across point-of-sale devices, printers, refrigerators, and even the robots that roam through the aisles in factories.

Competitors include Beevo (Europe), Fujitsu and Toshiba.

Hospitality (Revenue: $840mm / 12% of total; EBITDA: $105mm / 10% of total)

NCR’s offerings are embedded across every major process in a restaurant including the point-of-sale hardware and software, the digital platform for online ordering, the back office kitchen, loyalty programs and customer surveys, and payments.

The Company’s Aloha POS offering holds the #1 position in the US with 20-30% market share[8].

Restaurants are increasingly adopting digital initiatives – a trend accelerated through Covid – which brings with it a unique set of challenges for restaurant operators.  For instance, the Company cited Red Robin’s move to digital which required: enabling online ordering through a mobile device, tracking a customer’s geolocation to determine when to begin the order, and management of the entire payment process.  NCR’s software runs everything from the reservation, menu order (both in-person and digital), back office integration, and payments platform.  

Despite traffic-related headwinds in the sector, NCR continues to gain traction with its Aloha platform and customers added in Q3 exceeded plan.  70% of sales are to QSRs, which limits the exposure to small restaurant chains impacted by Covid.  Chipotle recently made news with its announcement of its digital kitchen offering[9]; less well known is that it is powered by NCR.  The Company expects to leverage its experience here with its other large customers (McDonalds, Chick-Fil-A, Starbucks).[10]

The Company also offers its Silver platform for small businesses, which is targeted at customers that sit between Square (for simple payments) and its Aloha Enterprise System.

NCR’s primary competitor is Oracle’s MICROS.  PAR’s Brink POS also competes in the QSR space and Lightspeed competes down-market in the SMB space.

Additional competition also exists from startups such as Toast.  Management has cited recent pressure from these smaller, uneconomic, VC-backed competitors.  Toast raised $400mm at a $5bn valuation in Feb 2020, but cut 50% of its workforce in April 2020.[11]

Additional Upside in Payments and Data Monetization

Payments

NCR acquired Jetpay in October 2018, a cloud-based payment processing offering.  The Company has since integrated the payments offering into its Retail and Hospitality point-of-sale systems.  Economics on each transaction are 30-50bps per dollar. 

Though a highly competitive area, NCR is able to leverage its ~25% share in POS systems to cross-sell payments.  Management cited an example where an existing Hospitality customer was using NCR’s Emerald platform to offer food delivery.  The pitch was straightforward: when a customer requests a refund, it’s a much simpler and faster refund process if the company running the digital platform is also managing the payments system.

In addition, there is a focus on vendor rationalization across restaurants and retailers.  Payments exist as part of back-end infrastructure and lacks differentiation from an end user’s perspective, which should result in the buying decision being driven by economics.  It remains to be seen whether NCR is able to compete on processing rates with scaled competitors, but the ability to cross-sell software and services should provide the cushion needed to build share and scale.

As an early indication of traction, the Company cited that 80% of new SMB Aloha adds in Q4 of last year included payments.[12]

RBC estimates the opportunity could represent a $280mm revenue stream by year-four (at a 33-40% EBIT margin), excluding the payment opportunity from its largest retail clients.[13]

Data Monetization

NCR collects data across its self-checkout and hospitality platforms.  With the acquisition of Zipscene, NCR has the technology in place to offer end-users promotions based on their restaurant spend.  While currently a small opportunity which we are placing zero value on, progress here should further entrench NCR’s position with retailers and restaurants.

 

Investment Thesis:

1)   NCR is misunderstood as an old legacy hardware company serving a dying ATM industry.  While new ATM hardware represents 18% of revenue, hardware has historically lost money and is only now approaching breakeven.  Even when including the attached software at time of sale and service installation revenue, ATM-related EBITDA represents only 6% of total EBITDA. 

Much has been written about a cashless society over the past 10 years (or longer) and of course with a deafening crescendo during the time of COVID.  Cash in circulation is in fact not declining, but rather is growing.  We only point this out as a matter of historical fact vs. perception.  NCR’s Banking revenue is actually not tied to cash usage, but based on service contracts with annual recurring fees, and reduced cash usage actually lowers the Company’s cost structure.

For those curious about ATM usage over time, we would encourage you to review the Cardtronic public materials for a more fulsome discussion.  For now, we will focus on why we believe the role of the ATM and its associated service requirements will remain important within the banking system.

As discussed, banks have been undergoing a multi-year digital transformation that involves reducing the number of branches and expanding high-functioning ATMs.  NCR’s ATMs are critical to the industry’s digital transformation exercise and should grow over the long-term. 

However, even if ATM hardware revenues decline, the economic impact is minimal.  We estimate that software and services revenue unrelated to new ATM sales account for nearly 90% of Banking EBITDA.

Segmented Banking Revenue and EBITDA Estimates

Note: ATM Hardware revenue reflects 2019 actuals.  Consistent with management’s guidance, we expect ATM Hardware revenues to remain at their current levels (~$900mm-$1bn annualized).  See “NCR Segmented Build” exhibit below for revenue segmentation methodology.

Our math also assumes that all of NCR’s ATMs sold include NCR software and services.  As indicated above, we estimate that 30%[14] of ATM units sold are hardware-only units.  Given the breakeven margin profile, a slowdown in hardware-only ATM sales would have no impact to NCR’s EBITDA.

The focus on ATM hardware also overlooks the material progress being made in Digital Banking and NCR’s expansion into services offerings for competitors’ ATMs.  

NCR’s Digital Banking products were a beneficiary of Covid.  The Company grew registered users organically by over 12% in each of the past two quarters.  As NCR’s economics are tied to usage, the result is a higher mix of high-margin recurring revenues.  Management expects continued growth through both new logos and expanded usage with existing customers.  Revenues should also scale further as additional software features are added and adopted.

In 2016, NCR’s principal ATM competitor, Diebold, acquired Wincor, a German-based competitor.  Our diligence calls indicated that NCR was a beneficiary of Diebold’s integration process, as Diebold’s ATM customers were left uncertain about Diebold’s software roadmap (i.e. whether it would be transitioned to Wincor’s product suite) and adopted NCR’s software as a result.  Further penetrating non-NCR devices with NCR’s software and services is a key area of focus for management and will drive segment EBITDA irrespective of new ATM hardware sales.

2)   Over the past 3 years, new management led by Michael Hayford, formerly of FiServ, and several related hires have reengineered the business through cost reduction and efficiency improvements while driving organic and acquisition led growth in the higher growth recurring revenue pieces of the business.  Between 12/31/16 and 9/30/20, Software and Services revenue mix has increased from 63% to 65% and is expected to ultimately reach 80% of revenue.

NCR’s CEO, Michael Hayford, and its executive chairman, Frank Martire, worked together for 15+ years at Metavante.  Frank served as CEO and Michael served as COO.  The two were at the helm as the Company scaled from a $100mm business to its $3bn acquisition by FIS.  Frank served as CEO and Michael served as CFO of the consolidated FIS and scaled the business to the largest financial technology company with >$6bn in annual revenues.

Shortly after Michael’s installment as NCR’s CEO in 2018, he restructured the business from functional siloes focused on hardware, software and services to business segments for banking, hospitality and retail.

Management Team

 

Management is targeting: 1) 80% mix of software and services revenue (from 65%), 2) 60% mix of recurring revenue (from 45%), and 3) 20% EBITDA margins (from 15%). 

Successful execution towards these targets would add >$320mm of incremental EBITDA.[15] We also expect the transition to a higher mix of recurring software revenue will result in a valuation re-rating.

Management’s compensation is tied to EBITDA objectives (80%) and NCR’s NPS score (20%).  Michael and Frank personally own a combined $10mm of stock. 

NCR’s Multi-Year Transition (RBC, 12/18/19)

The path to higher recurring revenue is partly a function of ATM hardware’s declining mix as software and services grows at a faster rate, but also reflects the following areas of strategic focus:

1) Increased adoption of bundled solutions.  Management is increasingly tying together hardware, software and services into one long-term (3-5 year) recurring revenue contract.  Examples include its digital banking software + ATM-as-a-service platform + branch managed services and its Aloha POS System + bank-end infrastructure software + payments platform.  Increased bundling will increase recurring revenues while further entrenching NCR in customer platforms.  Customers also benefit from vendor consolidation, cost savings, and a more tightly integrated end-user experience.  

 2) Expanded managed services.  Of the 6mm hardware units serviced by NCR, only half are for NCR’s branded equipment.[16] We believe this is a highly compelling opportunity as the expansion of managed services to non-NCR devices adds a touchpoint to new customers and can be leveraged to cross-sell other offerings.  For instance, NCR’s primary competitor in ATM hardware, Diebold, does not appear to have a competitive digital banking offering for community banks. 

 3) Tuck-in acquisitions.  There are numerous VC-backed software assets in the payments space that may be a good strategic fit for NCR.  An example is the acquisition of Jetpay, which NCR acquired for $184 / 2.9x LTM revenue.[17]  RBC’s estimate of reaching $100mm of EBIT would result in a 1.8x multiple[18].  We are supporters of similar acquisitions, which we characterize as small in size, but highly strategic when bolted onto NCR’s existing platform.

3)   Our SOTP valuation vastly exceeds the current market valuation.  As the growing, high margin segments become larger, the overall margin and growth trajectory of the business will inflect higher. The following is an overview of the key segments, estimated EBITDA contribution and growth rate.

 

NCR Segmented Build

ATM / SCO / POS Hardware: Revenue as per disclosure. EBITDA margin estimated based on management’s indication of “breakeven profitability.”

Digital Banking: Revenue as per management. EBITDA margin is an estimate.

Software – Tied to ATM Hardware: Revenue calculated based on total Software revenue less disclosed Retail software revenue less estimated Hospitality software to arrive at Banking software revenue of $1bn.  We then back out $400mm of Digital Banking revenue and $200mm of Unattached ATM Software revenue.  EBITDA margin is an estimate.

Software – Unattached ATM Software: Revenue as per management. EBITDA margin is an estimate.

Retail Software and Services: Revenue as per management.  EBITDA margin is an estimate. 

Hospitality Software and Services: Revenue as per management.  EBITDA margin is an estimate. 

Our total Software EBITDA margin of 33% compares to management’s stated EBIT margin “in the low-30s” and EBITDA margins of 35% and 31% in 2017 and 2018, respectively (EBIT margins were disclosed prior to 2019, to which we allocate D&A and SBC based on revenue mix).

Our total Services EBITDA margin of 15% compares to EBITDA margins of 17% and 18% in 2017 and 2018, respectively (EBIT margins were disclosed prior to 2019, to which we allocate D&A and SBC based on revenue mix). 

Our total Banking EBITDA margin of 16% compares to actual 2019 Banking EBITDA margins of 19% (based on disclosed EBIT and D&A and SBC allocated based on revenue mix) and RBC’s estimate of 18%.

Our total Retail EBITDA margin of 15% compares to actual 2019 Retail EBITDA margins of 11% (based on disclosed EBIT and D&A and SBC allocated based on revenue mix) and RBC’s estimate of 13%.

Our total Hospitality EBITDA margin of 12% compares to actual 2019 Hospitality EBITDA margins of 11% (based on disclosed EBIT and D&A and SBC allocated based on revenue mix) and RBC’s estimate of 16%.

 

Evaluating NCR based on readily-available disclosure might lead one to conclude that NCR is a collection of low-growth assets exposed to the headwinds facing the banking, retail and hospitality industries.  We believe this is a function of poor segment transparency. 

As you peel back the layers, NCR is already a recurring software and services business and uniquely positioned from a market share and technology perspective to capitalize on the evolving changes across each of its end markets.  On a consolidated basis, we estimate revenue growth of 4%. 

While not captured above, the Company should also realize significant operating leverage as software revenue scales.  Though we have estimated the EBITDA margins of 35% for ATM software revenue, gross margins are 90% and should flow to EBITDA with minimal incremental costs.

  

4)   We believe value will be unlocked either through the public markets or through a go-private transaction.  We believe a take-private of NCR is compelling.  The Company has a number of share leading platforms with outsized organic growth and acquisition opportunities.   The recurring revenue and low capital intensity are also quite attractive to sponsors and lenders.   Based on our expectation of forward underwriting EBITDA of $1bn, we believe PE can comfortably pay a >60% premium to the current share price. 

In May 2019, Bloomberg published an article citing a rumor that NCR was exploring a sale after receiving takeover interest.  At the time, it was widely believed that a private equity sponsor would be an ideal buyer given that NCR’s transition to a software company would be best executed under the privacy afforded by private equity. 

RBC speculated that a private equity firm could execute on NCR’s existing strategic plan and either re-emerge as a software / services company or be split into three separate assets: 1) Hospitality / Mobile PoS (integrated cloud-based Aloha platform with payments integrated), 2) Digital Banking-as-service (ATM-as-a-service + Digital Banking + branched outsourced services), 3) Retail solutions (cloud-based retail software, self-checkout hardware and gas station solutions).

RBC estimated that a private equity sponsor could pay ~$45 per share (+50% premium to the unaffected share price at the time) and fund the acquisition with 6.0x leverage.[19] 

Based on our illustrative LBO below, we estimate that to generate a 20% gross return, a sponsor can pay 10.0x EBITDA / >$45.00 per share with 5.0x leverage (50% of total).  We assume 2021 revenue and EBITDA consistent with our build above (approximately equal to 2019), with forecasted annual revenue growth of 4.0% and EBITDA margin expansion from 15% to 20%, in-line with management’s target, by 2025.

  

NCR – Illustrative LBO

Employee Benefit Plan based on 2019 actuals.

Capex based on 2019 actuals.  2020 capex is expected to be materially lower (YTD 9/30/20 Capex is $23mm). 

Capitalized software costs based on 2019 actuals, which was >$70mm higher vs. 2017 and 2018.

 

As for the likelihood of a transaction occurring, management was asked on its 11/17 investor event about whether they would be open to strategic alternatives should the public markets fail to reflect valuation expectations. Their response:

 

“You must be listening to our Board conversations. So we have a plan and we think we're executing the plan. The market clearly doesn't get that. I think it's a little hard with COVID, the mix is up, kind of the progress. December 3 is our Investor Day. And we're going to bring some transparency to some of the parts. So what are the various components, who do we comp to? And quite frankly, in a lot of cases, we're much bigger, more profitable and actually doing well competitively against some of the names that get very high multiples.

 

So hopefully, that will help. And as we go forward and execute, our board is very confident that the market will start to see that. I would tell you, there's nobody more disappointed in the fact that the market doesn't see the success that we see internally than Mike or Owen or Tim, the rest of the management team, we are highly incented by equity. And right now, we're not we're not highly incented in terms of our outcomes this year. So we get it. And if we're sitting here a year from now and we've executed all these things, and I've given you all the metrics to compare us against our peers who are much higher value, and our value hasn't changed.

 

I'd be remiss if I didn't say I'd be willing to look at different things. How do we unlock that value.  I don't think we're going to have to get there. I think the market is going to see it, but I think we have to be very cognizant of what do we do. How do we do it. And why is the value not being represented in our stock price today”

 

We found the response highly encouraging as it both reflects management’s understanding of the need for enhanced disclosure around the various business segments and the openness to a sale should the trading multiple remain depressed.

 

Valuation:

While NCR lacks direct public company comparables, below are relevant public comps. 

Comparable Companies

Note: NCR NTM EBITDA reflects estimated $1,045mm EBITDA as detailed above.  NCR revenue growth based on our estimate as detailed in the segment build above.  Growth rates for comps based on CapIQ consensus.

NCR trades at a one-turn premium to Diebold despite a superior margin and growth profile.  NCR’s Software EBITDA margins are approaching FIS’s, which is trading at >18x forward EBITDA.  While FIS warrants a premium multiple given its scale, we highlight it only to shed light on the magnitude of value that we believe can be unlocked through a SOTP valuation.

Though not direct comps, PAR Technology (PAR) and Agilysys (AGYS) are smaller competitors in the hospitality space with POS hardware and software.  Both companies trade at ~6x Revenue, despite lacking the scale, share position and profitability profile of NCR.

As another point of reference, Oracle acquired MICROS, the #2 player in Hospitality POS behind NCR, in 2014 for 14x EBITDA.[20] 

For our SOTP, we have ascribed zero value to NCR’s hardware businesses, a 10x multiple to its Software assets and 8x multiple to its Services assets.  We arrive at a share price of $40.38, 40% above the current trading price.

NCR SOTP Build

 

NCR’s FCF yield of 10% also provides another avenue for equity appreciation through debt paydown or share buybacks.  Though we expect FCF to be a less relevant metric as NCR’s transition to software and services progresses, as a check on valuation a 6% FCF yield would result in a share price of $46.54, +60% above the current trading price.

Normalized FCF and Implied Share Price at 6% FCF Yield

 

 

Risks:

1)   Continued pressure on bank capital budgets.

A lengthy pause in bank capital spend is likely to impact both new ATM hardware units and adoption of NCR’s digital offerings.  Smaller banks, the majority of NCR’s digital banking customers, may also be slower to ramp up branch transformation investment. 

2)   New competitors in Digital Banking.

The Digital Banking industry is highly competitive and of interest to numerous scaled players.  While the industry today remains fragmented, there remains a risk that a larger player with substantial resources will seek to compete more aggressively.

3)   New competitors in the Retail and Hospitality digital transformation.

The digital transformation occurring across retail and hospitality is well understood but early in its transition.  Given the importance of scale and first-mover advantages, we would not be surprised to see competition heat up as vendors increasingly seek to own as much of the digital transformation as possible.

4)   Execution.

The changes occurring across each of NCR’s end markets are driving opportunities for growth, but require successful execution to capitalize on the evolving environment.

5)   Increased investment.

NCR’s growth opportunities are largely driven by its software offerings.  Continued success is likely to require ongoing, and perhaps increased, investment in R&D and software development. 

6)   Acquisitions of expensive software startups.

Management has been prudent in its M&A track record to date and has indicated they will continue to be.  However, if management changes course and seeks to acquire scaled software assets – perhaps to stay competitive – they will certainly be acquiring assets with multiples higher than NCR’s.

 

 

 


 

[1] Software and services mix as of 12/31/19.  Mix as of 9/30/20 is 71%, which we believe is overstated given depressed hardware sales in 2020.

[2] CS research, 2/22/17.

[3] 11/19/20: “We've given a range of $220 million to $250 million a quarter. We think that's where we'll settle in. We saw that third quarter. And we've said, over the next few quarters, we think that's about the run rate. We've built a cost structure that is built toward that, we can flex it up, and we're much more comfortable selecting down. And we've recently put in a lean factory, which is paying huge dividends as we bring our procurement, our operations and our services together. So they're hand in glove as they go-to-market and look at the total cost. So we feel really good about the cost. But we think the volume falls in that range.”

[4] Estimate based on channel checks.

[5] RBC research, 12/17/18.  The Company has cited half of its hardware devices are non-NCR devices, which includes ATMs, SCOs and POS devices.

[6] See exhibit below for additional revenue segmentation and methodology.

[7] NCR Q3 20 call.

[8] Nov 2018 analyst day.

[9] https://www.prnewswire.com/news-releases/chipotle-to-open-its-first-digital-only-restaurant-301170710.html

[10] 11/19/20 investor call.

[11] https://www.cnbc.com/2020/04/07/toast-cuts-50percent-of-staff-as-coronavirus-forces-restaurants-to-close.html

[12] Q4 19 call.

[13] RBC research, 3/4/20: “Assumptions are: 1) an NCR install base of ~100k stores, based on Radiant Systems’ prior form 10-Ks; 2) revenue per store/location of ~$2M annually, which is an average of 14 quick-service-restaurant clients; 3) NCR renews 25% of its existing base per year, with 60% of those selecting the company to process payments; and 4) by the end of four years, payment penetration among NCR’s client base is 60%. We do not assume NCR wins any payment volume from its largest retail clients.”

[14] Estimate based on channel checks.

[15] Based on LTM revenue of $6.5bn x 5% EBITDA margin enhancement; using 2019 revenue as a baseline would generate $350mm of incremental EBITDA. 

[16] RBC research, 12/17/18.

[17] https://www.ncr.com/news/newsroom/news-releases/company/ncr-steps-into-payments-announces-definitive-agreement-to-acquire-jetpay

[18] RBC research, 12/17/18, estimated $80-$100mm in EBIT on $240mm revenue opportunity.  RBC’s estimate for revenue has since increased to $280mm. 

[19] RBC research, 5/10/19.

[20] RBC research, 5/10/19.

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

1)   12/3/20 Investor Day;

2)   Enhanced disclosure around business segments;

3)   Progress towards stated 80/60/20 targets;

4)   Takeout interest

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