Investors in growth and early-stage public companies have had a rough few months. This is exemplified in the price of the Renaissance IPO ETF, which is down over 32% in the last six months, compared to the S&P 500, which is only down a measly 5% over that period. Many stocks have fared even worse than the IPO ETF, down as much as 50% or 70% in just a few months.
One of these stocks is Latch (LTCH). The smart-lock and real estate software company has put up great growth numbers, but investors have soured on the stock recently, with shares down 67% in the last six months.
Is it time to buy the dip on Latch stock? Let's find out.
Good Q4 results and poor guidance
Latch reported its fourth-quarter and full-year 2021 earnings on Feb. 24. Revenue was up 94% year over year to $14.5 million in the quarter, with full-year revenue hitting $41.4 million. Cumulative booked units, one of the most important metrics for Latch investors to track, hit 590,000 in Q4, up 94% year over year.
Why is the cumulative booked units metric so important? With Latch's unique business model, which signs long-term deals with apartment buildings that may not materialize as revenue for a few years, it signs or "books" a lot of future revenue under contract before it shows up on the income statement. Since the company makes money by charging a monthly subscription fee per apartment unit to building owners once a building becomes operational, cumulative booked units is the best metric for understanding Latch's deal pipeline and backlog.
Image source: Getty Images.
While the backlog looks strong, growth in active apartment units has been slower than investors expected due to the supply-chain troubles hitting the construction industry. This can be shown in Latch's software and overall revenue guidance for 2022.
Management expects software revenue of $14 million to $15 million and total revenue of $75 million to $100 million -- the majority of non-software revenue is Latch selling actual smart locks and hardware for this year. These sales were much lower than what analysts expected coming into the report and are the biggest reason why Latch stock is nearly 50% so far in 2022. As a result, consensus analyst estimates for 2022 revenue dropped sharply from $150 million before the report to around $87 million today.
LTCH Revenue Estimates for Current Fiscal Year data by YCharts.
Long-term opportunity remains intact, but cash burn brings concerns
In the short run, Latch is seeing some friction in turning its booked contracts and hardware revenue into software revenue. Since it sells its hardware as a loss-leader with negative gross margins, growth in high-margin recurring software revenue is the most important financial metric for investors to track as an indicator for the long-term health of Latch's business. The segment might seem tiny right now, with only around $15 million expected in 2022, but there is a long runway for software revenue to grow.
For one, it should be able to grow its annual software revenue fivefold just from its backlog of 590,000 cumulative booked units. Latch charges around $10 each month per apartment unit. Just from this existing backlog, that should translate to approximately $71 million in annual software revenue once these units become operational in the next few years (possibly longer if supply chain problems persist). Plus, with around 300,000 new apartments built each year in the United States, Latch should be able to steadily grow cumulative booked units over the next decade.
Management is trying to accelerate growth in cumulative booked units -- and therefore software revenue -- by partnering with other smart-lock manufacturers, announcing deals with companies like Marks USA and TownSteel. This enhanced focus on getting Latch software into as many apartment buildings as possible is a smart move since that is where all of its profits will be generated over the long term. Simply put, the more apartments Latch has under contract, whether with its hardware or someone else's, the better.
On the negative side of things, Latch is very unprofitable right now and burning a ton of cash each year. In 2021, Latch used $106 million in cash flow from operations. This cash burn looks bad relative to revenue of $41.4 million because of the focus on getting low margin hardware into the door and the fact that once Latch's sales team signs a deal, high margin software revenue doesn't show up for multiple years.
Once more software revenue comes online, this cash burn should abate over time, and management thinks its current cash pile of $283 million will be enough to fund growth until the business turns cash flow positive. Still, as investors, it will be important to track this cash burn because if it spirals out of control, Latch's business will be in trouble.
What about the valuation?
As of this writing, Latch has a market cap of $536 million. With the projected revenue the company has a forward price to sales (P/S) ratio of six which might seem reasonable to some. However, this is very expensive relative to the software revenue guidance of $14 million to $15 million -- remember, all other revenue is negative-margin, and when this is ignored the stock has a forward P/S ratio of 36.
Latch stock is expensive when looking at next year's revenue numbers. But if you take a longer view and believe the company can get to north of $100 million in software revenue within a few years while maintaining 90% gross margins, Latch stock could be much higher five years from now. Although this will require a lot of revenue growth, and it definitely doesn't come without risk, if you are confident in the business's trajectory over the long term, now could be a great time to take a position in Latch stock.
