The largest industry in the world is real estate, valued at $326.5 trillion at the end of 2020. Like in most industries, technology players are going after parts of the real estate supply chain, trying to help the industry get more efficient and improve the customer journey. Some companies, like Zillow, have tried and failed so far to digitize part of the real estate market, while others are growing quickly with well-thought-out solutions.
One of these other companies is Latch (LTCH 2.26%). The recent entrant to the public markets is growing rapidly, has a small market cap, and is going after a large part of the real estate industry. In my mind, this gives the stock a good chance to go up 10x in the next 10 years.
What is Latch?
Latch sells smart-lock hardware and software programs to residential apartment buildings. It works with real estate developers before a new building goes up, but increasingly is pushing into retrofits for older buildings as well.
The business model is a bit unique. First, Latch will reach out to a real estate developer, typically someone building a large apartment complex, and try to sign a long-term contract for Latch's products. Once the contract is signed, Latch reports the contract value as bookings, which is a financial metric it gives out every quarter. After one to two years, or however long it takes the building to get finished, Latch will have its hardware installed on every shared door and apartment front door in the building.
It typically sells hardware products at cost, which it makes up through its recurring revenue software bundle. Once an apartment starts operating, the real estate developer will pay Latch for its software programs, typically paying multiple years upfront. Latch charges around $7-$12 a month per apartment unit to the owner of the building, depending on how many modules they decide to buy. With the software up and running, tenants are able to access their unit and every shared space in the building through the Latch mobile application, making the building more secure and efficient than using physical keys. The building managers get access to Latch's operating system, which helps them manage all the building's needs and deal with tenants.
Over the long term, two key indicators for Latch's success will be the number of cumulative booked units under management (which will directly correlate with software revenue) and booked annual recurring revenue (ARR), which shows the total amount of ARR Latch has signed under contract.
Latch is seeing rapid growth from a small base
Latch is a very young company, founded in 2014 by Luke Schoenfelder, who now serves as the company's CEO. Seeing as real estate projects take a long time to build, Latch is still early in its financial journey. In the third quarter of this year, it only brought in $11.2 million in revenue, the majority of which was from hardware. Software revenue was only $2 million in the period, which is quite small compared to Latch's $1.1 billion market cap.
However, the company is showing strong growth and has tons of forward-looking metrics that should leave investors confident. For one, total bookings in Q3 hit $96 million, up 181% year over year, which shows the strong pace of contract signing that Latch is doing. Cumulative booked units, which is the number of apartment units Latch has under contract, hit 532,000, growing 101% year over year. Assuming each unit is paying approximately $10 a month based on what Latch has shown investors, this should translate to $64 million in software ARR once all these buildings are up and running.
Latch estimates there are 32 million multi-family apartment units in North America. If the company can approach a 10% market share over the next decade, this should translate to strong double-digit percentage revenue growth for years to come. And this doesn't include the optionality of expanding to Europe, commercial buildings, and ancillary services, all of which Latch has started or plans to start soon.
Latch's valuation is high, and it doesn't come without risks
Latch looks like it has the potential to grow its sales at a high rate for many years, but the stock is still expensive based on its current market cap. Looking at Latch's trailing-12-month revenue of $34.3 million, the stock has a price-to-sales ratio (P/S) of 32, which is pricey no matter how you slice it. There is a clear path to this coming down rather quickly as more and more of Latch's booked apartment units become operational. But if growth slows at some point over the next few years, that could be bad news for the stock price.
There is also the risk that Latch's products will not be as widely accepted among property developers as investors are assuming. The products are perfect for a new apartment building, but it's possible a lot of lower-income developments that are older don't want to spend the money on these hardware/software upgrades, leaving Latch's addressable market smaller than 32 million apartment units.
Overall, Latch stock is a great candidate to 10x over the next 10 years. This doesn't mean the company is guaranteed to put up those returns, but for those investors with higher risk tolerance, Latch stock can be a nice addition to your portfolio.