Special purpose acquisition companies (SPACs) are the latest trend to hit Wall Street. 89 SPAC mergers have closed so far in 2021, which means 89 new stocks are now available for anyone to potentially invest in. The problem is, with so many companies entering the public markets, it can be tough for investors to narrow down which companies, if any, they should invest in. One recent SPAC with strong potential is Latch (LTCH +0.00%), which sells software and hardware systems for residential buildings.
Is Latch the next great growth stock? Let's take a look.
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An operating system for apartment buildings
Through a combination of hardware and software tools, the Latch Operating System (LatchOS) helps building owners manage their properties. Latch hardware goes on virtually every door in an apartment building, replacing the need for physical keys by connecting each door to the Latch smartphone application, which every resident of the building can download for free. This allows owners to offer what Latch calls smart access to their buildings.
With the LatchOS, building managers can instantly change who has access to what rooms, and for residents, it allows them to manage their apartment and access shared spaces all from their smartphone. On top of its core smart access product, the LatchOS can manage deliveries, connect to smart devices and intercoms, and it offers a growing list of ancillary services to residents and building managers.
In its SPAC presentation, management said that around one in 10 new apartment buildings in the U.S. are utilizing the LatchOS. It costs around $7 to $12 per month per apartment depending on how many services the building wants. Why are apartment owners willing to pay this much each month for Latch? Because when on the system, residents should have a better living experience, which allows owners to price rooms at higher rates. Building managers also see their operations become more efficient by having everything connected to one software platform, allowing owners to save on various expenses.
It is growing quickly
As you might expect from a company winning 10% of new apartment builds, Latch is growing rapidly, albeit from a small revenue base. In the first quarter, total revenue hit $6.6 million, up 143% year over year. Just over $5 million of this revenue came from hardware sales, which Latch actually sells at a negative gross margin of around 20%.
Why is Latch willing to sell hardware for so cheap? Because it typically can attach long-term software contracts to it. At first glance, software revenue looks weak at only $1.6 million last quarter. But since Latch's average contract with a building is more than six years, software bookings (the total amount of customer commitments in a time period) are much higher than what it reports under quarterly revenue. In the first quarter, Latch had $43.5 million in software bookings, up 84% from the same period a year ago.
Latch's software products carry a gross margin of more than 90%, which should quickly help it make up for the hardware devices it is selling below cost. Growth in software bookings is the key metric for investors to watch when evaluating Latch's business over the next few years.
New opportunities abound
Latch has three categories it is focusing on outside of its core North American residential market.
First, Latch just released a commercial office solution, which will target another large part of the global real estate industry. All LatchOS modules like smart access and delivery management can now be utilized by commercial building owners. This is a logical next step for Latch and should help propel its bookings growth over the next few years.
Second, the company continues to add services for residents to its mobile application. In its SPAC merger presentation, the company mentioned it plans to sell services like renters insurance and internet service through the app. Essentially, it hopes the Latch app is the only place new residents have to go when moving into a new building.
Third, Latch is targeting European countries as the first stage of its expansion outside of North America. Through its partnership with Tishman Speyer, a real estate company that owns the SPAC Latch merged with, the company is expanding its target market to the 93 million apartments located in Europe.
Valuation is steep
As most SPACs tend to be right now, Latch trades at a nosebleed valuation. With a current share price of nearly $13, the stock trades at a market cap of $1.83 billion. Backing out the approximately $500 million in cash on its balance sheet, Latch has an enterprise value of $1.36 billion. This may look extreme relative to its quarterly revenue numbers, but Latch is guiding for $290 million to $325 million in total bookings this year, which is a lot better than what it has to report for its revenue number. And if you believe management's projections for $249 million in annual free cash flow by 2025, a market cap of $1.86 billion could even start to look cheap a few years from now. It will take strong execution and a ton of growth to get there though.
Latch stock trades at a premium valuation relative to most companies on the market. But if you believe it can grow rapidly as it deploys its LatchOS into millions of apartments and office buildings worldwide, the stock could be a great long-term holding in your portfolio.
