Almost all special-purpose acquisition companies (SPACs) that came public in 2021 have been clobbered. As of November 2021, SPACs had dropped an average of 9.9% in price from their merger dates, and that does not account for the volatile start to 2022.
One SPAC that stood out during this drawdown, however, was Latch (LTCH -1.85%). Latch provides smart-lock technology to large-scale apartment buildings. It also has a high-margin software business that allows landlords to overlook their apartments to ensure safety and security. Latch's impressive products haven't made the stock immune to drops, however: Shares are down almost 79% from their all-time high set in September 2021.
The company might have lost a little spark after reporting its fourth-quarter earnings on Feb. 24, however, which revealed some risks that might deter you from buying today.
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Another failed SPAC?
Many SPACs were known for their aggressive projections of their future growth. SPACs -- according to the Harvard Law School Forum on Corporate Governance -- on average projected an annual revenue growth rate of 116% when they came public.
These companies got a little carried away with their growth estimates, considering many of them have failed to attain these goals now that they are public companies. Latch is one of these overly optimistic prognosticators. In 2021, the company earned $41.4 million in revenue, yet in its SPAC presentation from early 2021, it had estimated $49 million in revenue for that year.
Additionally, the company's initial projection for 2022 revenue was $173 million, but in Q4, the company decreased that estimate by 49%. It now expects only $75 million to $100 million in 2022 revenue.
This was not the only reason shares of Latch dropped after it reported Q4 earnings. The company's gross margin also declined sequentially. In Q3 2021, the company's gross margin was breakeven, but in Q4, it sank to -27.5%.
This drop resulted in bottom-line pressure for Latch. The company lost $54 million in Q4 alone, which grew 181% year over year. The problem is that this net loss growth significantly outpaced its Q4 revenue growth of 94% year over year. To make matters worse, its free cash flow burn in 2021 was $114 million. The company has just $284 million in cash and securities on the balance sheet to fund these losses, so if these continue to increase as they did this year, Latch could have trouble staying afloat.
A shift to software
The news wasn't all bad in the company's fourth quarter, however. Latch announced a shift of focus to its software products rather than its hardware products. Its hardware -- the company's smart locks -- make up the majority of Latch's total revenue, but its margin on those locks is negative, while the software revenue margin was 91% in Q4. Latch management noted that it wants to develop fewer hardware products directly and instead allow second-and-third-party manufacturers to build the hardware with embedded Latch software capabilities.
This evolving business mix, in theory, will improve the margin profile and unit economics for Latch, which could reduce the company's net loss and free cash flow burn. On the other hand, the company will make less revenue on hardware products in the coming quarters, and software revenue only made up 18% of revenue in Q4, so the move will also hurt the company's revenue growth in the short term. This trade-off explains the company's underwhelming 2022 top-line guidance.
Another silver lining in the company's Q4 results was its bookings, which grew 113% year over year to $97 million. Latch's bookings represent intentions from apartment managers to use Latch hardware and software once the apartment building is built, so this strong bookings expansion shows that the company's products are still in high demand.
Is Latch a buy?
This shifting focus could be what turns Latch into a high-margin business, but it does not come without risk. It will likely impact the company's revenue in the short term, and this business model has no guarantee of success. For this reason, along with the concerns about its free cash flow burn and increasing net loss, it might not be the best idea to load up on shares right now.
That being said, if you already own shares of Latch, you might want to avoid selling. The industry that Latch is attacking is worth $54 billion annually in the U.S. -- a massive opportunity that could get bigger if it can succeed internationally. This company is a long-shot investment, but if it can successfully pivot its focus to software and improve its financials in the process, Latch has the potential to be an incredible investment. The company trades at 16 times sales, which may turn out to be an amazing bargain if you look back at it 20 years from now.
