Lightspeed Commerce (LSPD) is a software as a service (SaaS) company that offers POS services for small-to-medium businesses.
We are neutral on the stock.
Growth Catalysts
Lightspeed operates in the point of sale software market. The market was valued at just over $9 billion in 2020. The industry is expected to grow at a compound annual growth rate of 9.5% between 2021-28. This demonstrates that the industry is healthy and growing fast.
This can be attributed to the growth of online orders and payments, as well as the increasing importance of analytics to better understand customer patterns and trends. Thus, LSPD has industry tailwinds to help fuel its growth.
In addition, the company has been actively engaging in acquisitions to help accelerate its growth. With $1.8 billion in cash and cash equivalents, this may not be a bad idea if the acquisitions are made responsibly.
Concerns
When it comes to Lightspeed, we have some concerns that need to be addressed. To begin with, the industry is very competitive with players such as Shopify (SHOP) and Block (SQ). To us, it appears that Lightspeed might be having some trouble keeping up with the leaders.
When looking at gross margins, LSPD has been seeing a steady downtrend over the past several years. In the Fiscal Year ending on March 31, 2019, the company reported a gross profit margin of 69.6%. The gross profit margin was 67.1% and 57% for Fiscal Years 2020 and 2021, respectively. This number drops even further to 50.6% when looking at the last 12 months.
A similar pattern appears when looking at EBIT and free cash flow margins, with the only difference being that the TTM numbers are slightly better than the Fiscal Year 2021 numbers.
This suggests two possible scenarios. The first one is that LSPD doesn’t really have a competitive advantage because competitors are chipping away at its margins.
In addition, it shows a lack of operating leverage as the company’s revenues continue to grow. Ideally, we would like to see margins expand as revenue grows because it means that it is scaling efficiently.
The second scenario is that Lightspeed has been acquiring companies with lower gross margins, which are weighing down the overall number. Either way, we like to see companies expand margins because falling margins tend to lead to a valuation multiple contraction, which has been the case for LSPD recently.
Furthermore, another metric we like to look at when assessing SaaS companies is the rule of 40, which is calculated as revenue growth plus free cash flow margin. Companies with a number greater than 40 tend to outperform those with a number lower than 40.
Lightspeed crossed above 40 for the first time in Fiscal Year 2021, which ended in March, coming in at 41%. In the last 12-month period, the number has ballooned to 153.2%. This appears amazing on the surface, but the growth in revenue was aided by acquisitions.
When we use free cash flow after acquisitions margin, this number falls deep into negative territory:
- Revenue: $484.2 million
- Revenue growth: 175.7%
- Acquisitions: $560.7 million
- Acquisition as a percentage of revenue: 115.8%
- Free cash flow margin: -22.5%
- Rule of 40 with acquisitions: 175.7 – 115.8 – 22.5 = 37.4%
The last fiscal year in which LSPD had an immaterial amount of acquisitions was in 2019. The rule of 40 for that year was only 23.3%. This suggests that the current number is inflated, and the probability of long-term outperformance is lower without the use of acquisitions.
Wall Street’s Take
Turning to Wall Street, Lightspeed has a Moderate Buy consensus rating, based on 10 Buys, two Holds, and one Sell assigned in the past three months. The average Lightspeed price target of $49.33 implies 55.9% upside potential.
Final Thoughts
Lightspeed has seen strong revenue growth over the past few years. However, its declining margins and rule of 40 metrics leave us neutral on the stock as we believe there may be better opportunities elsewhere.
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