1 Small-Cap Stock With Monster Growth Potential

Latch (LTCH -1.85%) is a smart lock company. Its LatchOS operating system powers a range of proprietary hardware, including door-mounted access controls, delivery assistants, and intercoms. To that end, Latch streamlines the entry experience for both tenants and property managers, making it possible to unlock doors and permit access through mobile apps and cloud-based software.

In this Backstage Pass video, recorded on Nov. 29, 2021, Motley Fool.com contributor Will Healy discusses Latch, explaining why investors could see substantial returns in the years ahead. Motley Fool contributor Danny Vena also appears in this clip.

Will Healy: The next company I'm going to talk about is Latch. Latch was founded in 2014. It was bought by a SPAC called TS Innovation Acquisitions in June, is a software-as-a-service provider, and it's a building operating system basically. It'll handle the building security and building functionalities such as the so-called smart home and they offer software products and services. It's about $1.2 billion market cap.

It provides equipment, but the real revenue driver in the future is going to be the subscription services to the operating system that runs everything. They typically target apartment complexes and commercial buildings. They are actually in more than one out of 10 new apartment buildings. They've been focused on that. They've also announced Latch M. Latch M will allow them to target existing buildings to retrofit their technology to that, so it's not just new buildings.

In Q3, they brought in $11 million, that was a 120% increase year-over-year. But I think the real number here is total bookings. And total bookings are business that they plan to have -- you know, they contract with the new apartment that's being built to provide their operating system and other equipment -- but they're not subscribing yet because the building is not yet operational. Well, total bookings for the quarter were $96 billion, not only was up 181%, but that points to where revenue is going to be going, probably in the near future.

Fun fact is since 2017, they have never lost a customer, so this is a very compelling system that they have here. However, it's going to take a while to get the profitability, as their cost of revenue was all those what their revenue was. Then they're operating expenses grew 135% during that time. That amount to a $34 billion loss, which rose 116% year-over-year.

However, they do have $240 million of cash on hand, so they can go a few more quarters before they have to borrow more money or turn back to the public markets. The SPAC deal, they accumulated about $448 million in cash. As I said, it should tide them over for the foreseeable future, anyway.

The company gets about $487 million in assets, about $63 million in liabilities. That gives a book value of $425 million, which with $1.2 billion market cap, it's trading at less than three times book value. That should bode well for the stock's future. It's just because, again, the total bookings are just massively, so that's $11 million to $96 million, that's almost nine-fold. There's going to be some pretty serious revenue growth coming. The stock has fallen since the IPO. I think people were very impatient for that revenue to come in. But I think once some of these bookings actually turned into revenue, I think the stock could really take off.

Danny Vena: I was intrigued by the fact that you said they've never lost a customer. My question about that is, so if they're building an apartment building and they install essentially the operating system for these smart locks into the building, are they then a captive audience? Is this high cost of switching situation once they've got that operating system in place? Doesn't it become very difficult to switch to another provider?

Will Healy: Yeah, that's the beauty of it because you can see like a [Alphabet's] Google or Apple willing to compete in this business, and I'm sure they will and I'm sure they'll attract some of this business. But yes, once you install lots of equipment in a building, it's going to be very costly and time-consuming, distribute all out and put somebody else's equipment and operating system in this. I think this could be huge. I do own it myself and it's because I believe in this potential.

Danny Vena: This is actually one of the ones that I bought into a couple of quarters after they went public, and earlier than what I usually do. It's interesting that you mentioned Apple, because the company was founded by ex-Apple executives back in 2014. The other thing that I wanted to mention that you said their cost of revenue was almost as much as their revenue. That's not really surprising considering that they are a software-as-a-service business. Essentially, once they get enough customers to where they cover the cost of this revenue, then each new customer thereafter, the majority of revenue from that customer is going to drop to the bottom line, right?

Will Healy: Yeah. This is going to be basically a services business. It reminds me a little bit of Roku, even though Roku is a different business because it looks like an equipment company on the surface rather. But its core, is an operating system that can derive massive revenue over time.

Danny Vena: Definitely, and that's the thing that appealed to me about it, is the fact that first of all, you get these customers that are essentially locked in. Now, they could change their mind at some point and decide that they want to go to the route of switching to another provider, but that seems like that would be expensive. But, they've got their customers are essentially locked in and it's software-as-a-service business, which I'm always intrigued about.