|Shares Out. (in M):||35||P/E||0||0|
|Market Cap (in $M):||3,780||P/FCF||0||0|
|Net Debt (in $M):||-110||EBIT||0||0|
|TEV (in $M):||3,670||TEV/EBIT||0||0|
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Plenty of software businesses became radically overvalued during the tech boom of the past several years. Their valuations often became totally separate from their quality as a business and/or asset. But some of these companies actually are great businesses that merit an optically high multiple and that inverse truth is being forgotten subsequent to this sell-off. We believe that APPF is clearly one of those high-quality assets and either the market or a large PE firm will appreciate its fundamental merits again. Management has many levers to improve disclosure and take advantage of the drop in price for technical talent. For a business like this, 6.4x EV/NTM Revs is fundamentally too cheap and a compeling target for those same PE firms.
AppFolio (“APPF”) is a vertical market software company serving the real estate industry (primarily single family and multi-family residential, but also commercial, Community Association (CA) and student housing). The business was founded in 2006 and went public in June 2015. AppFolio’s software provides property managers with a system of record and system of action to track all of their data and automate their daily activities across their entire workflow. What does this mean? APPF’s goal is to try to embed themselves in everything real estate-oriented, from sourcing and screening tenants to handling all payments (both from renters and to vendors) and handling maintenance requests.
APPF’s first product was AppFolio Property Manager (APM). APM is a tool that streamlines the accounting, record keeping, leasing, and document management associated with owning and leasing real estate. Since then, APPF has expanded the services offered to include many additional offerings. APPF aims to make property managers lives easier by eliminating manual data entry, excel files, email, etc. to save property managers time and money. Initially, APPF focused on a void in the market, providing a cloud native, user intuitive, good-enough solution for smaller property managers to replace excel and QuickBooks that was unserved by the legacy incumbents, RealPage and Yardi. Over time, APPF has added additional functionality, and launched a premium offering in October 2018 (APM Plus) that is targeted at larger clients with greater sophistication. The average unit per customer is 382 today (up from 271 in Q2 ’17) but the incremental customer has 793 units, and the unit / incremental customer has steadily been rising over the years.
As of 6/30/22, APPF has 17.8K customers and 6.83M units under management, and earns $26K per customer per year and $67 per unit ($5.60 / month). Revenue is split into three streams: core (29% of revenue), Value+ (68% of revenue) and Other (3% of revenue).
Core revenue is pure subscription revenue. It is charged on a monthly or annual basis (typically monthly). For APM: On average the cost is $1.40 / unit / month with a minimum $280 monthly spend but ranges by offering ($1.40 resi, $1.50 commercial, $0.80 community association). For APM Plus the cost is $3 / unit with a minimum $1.5K monthly spend. APM gives access to basic functionality such as record keeping, accounting, financial statement creation and analysis. APM Plus includes additional analytics tools that are desired by more sophisticated property managers including real-time data and custom dashboards, revenue management and optimization tools, and account management tools.
Value+ revenue is a mix of subscription revenue and usage-based revenue. Subscription revenue is invoiced monthly in advance of subscription period, usage-based revenue is based on a flat rate per transaction with no minimum usage commitments and is invoiced monthly for services rendered in the preceding month. Subscription revenue features include: company website, maintenance contact center, and the AI leasing assistant. Usage revenue features include: premium leads, tenant screening, electronic payments, insurance, tenant debt collection. The largest categories of Value+ revenue are payments, screening and insurance.
Other revenue is transactional revenue related to implementation and onboarding or other fees related to customers who are not using core solutions (e.g. legacy customers from acquired businesses) as well as some website design revenue. This is ~3% of revenue today.
AppFolio’s offering is extremely well regarded by its customers and is generally lauded for its easy-to-use interface, strong customer service, and consistent release of innovative and beneficial features. AppFolio customers utilize the product every single day, multiple times per day, and run their entire business around the software. The introduction of AppFolio, along with its consistent release of new features, enable property managers and their staff to save significant time and resources, which can be dedicated elsewhere, or can eliminate the need to hire an additional employee (which is a very significant expense).
Importantly, AppFolio is a tiny percentage of a property owner or manager’s overall cost structure. For an owner, vs an average monthly rent of $1.4K, AppFolio is just ~$5 to $6. And for a property manager charging 10% of rent, this is $140 of fees vs the same $5 to $6. It is also important to highlight that a significant % of that $5 to $6 is paid by the tenant and is a pass through from the property manager (eg. payments, screening, insurance), so AppFolio is a tiny % of customer’s revenue and a very small expense item vs other line items (staff expense is by far the biggest line item).
As a result of the above, AppFolio has periodically taken period price increases with a negligible impact on retention levels. The company does not disclose gross retention, but based on our primary research, we believe gross retention is best-in-class, in the ~95% range.
What is the competitive landscape?
Competition varies by sub-segment. At the lower end of the market, AppFolio is often the first integrated provider of software a customer has used, replacing or augmenting Quickbooks, excel and email. Other lower end competitors include Yardi Breeze, Buildium (acquired by RealPage in December 2019), Propertyware (acquired by RealPage in 2009), or Resman. At the higher end of the market, AppFolio is more likely to encounter RealPage (founded in 1998 and acquired by Thoma Bravo in April 2021) and Yardi (founded in 1984 and privately held). Other competitors include Entrata and MRI. RealPage is a roll-up of many different acquisitions that customers complain don’t integrate very well together. Yardi has been around for decades and has a user interface to match that. Given the mission critical nature of the technology, customers are sticky and retention rates are high, but our sense is AppFolio is steadily chipping away at the incumbents with a cloud native interface and stronger and more motivated team.
What makes this interesting?
After its 2015 IPO, APPF reached a peak of $184 in Dec 2020 (~18x NTM revenue), but since then the stock has languished, reaching a trough of $83 this May, and currently at $108 (6.4x NTM revenue).
Optically, AppFolio’s financial results appear to be unimpressive. EBITDA margins rose from -15% in 2015 to a peak of 21% in 2018, but have compressed to just 6% on an LTM basis, and in dollar terms, from $52M in Q3 ’20 to just $25M today. The bear case, as documented in heffer504’s June 2020 short write-up (great call from when the stock was $156 vs $105 today), is that the market is saturated and competition is increasing between AppFolio and the legacy incumbents, RealPage and Yardi. The other bear case is that a substantial amount of revenue from Appfolio is “payments” and is lower margin and thus merits a lower multiple.
Our perspective is a bit different. While we acknowledge that the market does not have the same greenfield opportunities that were prevalent five years ago, we view AppFolio as a steady share gainer vs the legacy players over the long-term. And while APPF’s margins have suffered, critically this has come from increased R&D spend, and generally not from reduced sales efficiency. In fact, APPF’s customer acquisition paybacks remain best in class vs other software peers, at ~14 months.
While AppFolio reached moderate EBITDA margins of 21% in 2018, we believe the management team recognized they were better served accelerating investments in their product to enable them to push further up market and capture a larger opportunity, than to optimize for margins today. R&D has gone from ~$20M annualized (11% of revenue) in 2018 to $91M annualized (20% of revenue) during this time period. There have been significant investments made in bolstering the platform for larger clients, resulting in a steadily increasing customer size, and strong growth in new units (17.4% yoy in Q2 2022). In addition, our sense is there has been substantial investments in the release of AppFolio Stack in June 2022, as well as investments in a new offering for real estate investors. One common complaint from larger customers was that they wanted the ability to integrate with other point solutions, which previously AppFolio did not offer. With the launch of Stack, we believe this may remove a significant barrier to tapping a larger sized customer.
In terms of payment revenue, while we acknowledge it is a lower gross margin profile than pure subscription revenue, we believe that it comes with very low R&D and G&A associated with it, so it is actually not dilutive to EBIT margins.
Despite its size ($3.8bn market cap), APPF does not attract much attention. Only 6 analysts cover the stock (2 buys, 4 holds), none of which are from bulge bracket firms (William Blair, DA Davidson, KBW, Stephens, Keybanc and Berenberg). Morgan Stanley and Credit Suisse used to cover the business (they were lead underwriters) but both analysts left their firms and coverage was dropped.
AppFolio historically has not offered much in the way of disclosure. Beginning in Q1 2017, APPF no longer provided a Q&A period on its earnings calls. Analysts that have questions are invited to submit them in writing, and the company periodically published its responses on its website, but has not released anything for quite some time. The company does not attend investment bank conferences (it briefly participated in 3 in 2016 following its IPO, but hasn’t since). The company only provides annual guidance (not quarterly) and only recently began providing guidance on EBIT.
AppFolio’s primary backer is the Investment Group of Santa Barbara (IGSB), who has a very impressive track record of funding and guiding businesses throughout their lifecycle, including AppFolio, Advent Software, and The Learning Company. IGSB & IGSB partners own ~$0.9B of stock / ~25% of shares (and have sold minimal shares since 2015) and control ~52% of the vote. This is a very actively involved board: the proxy tells us they met 14 times in 2020 and 13 times in 2021.
We think the BoD and management are broadly mindful about the stock price over the medium term and since the stock has languished over the past couple years, we are seeing some signs of increased disclosure. The company hired a new CFO in September 2021, who previously spent 9 years at ServiceNow, most recently as Chief Accounting Officer and was the interim CFO when Mike Scarpelli departed (as well as spending formative years under him). Since her appointment, we have seen additional disclosure (guiding to EBIT as well as revenue), provision of non-GAAP metrics, and the company will be holding its first analyst meeting in several years in the coming weeks.
In full disclosure, this write-up won’t be for everyone, as it relies on revenue and gross profit multiples, which we understand some members don’t view as relevant. We are sympathetic when looking at some companies! But this is a 'clean' cost structure that should translate to strong earnings power and that's been validated by active PE/strategic interest in the space. They may be willing to accept lower unlevered IRRs than many on VIC, but they also have a very clear sense of what the underlying cost structure is for very close peers.
We think APPF can grow revenue at a ~23% CAGR from 2021-2026, consisting of 12% CAGR in units and the balance in revenue / unit, from a combination of increased usage of services, increased penetration of services, introduction of new services, and pricing. Over the long-term, we think this is a business that can take pricing well in excess of inflation.
At 6.5x ’26E revenue (10x gross profit), when we still think the business may be growing revenue in the mid-teens, this would equate to a ~20% IRR.
What is the anchor for these revenue and gross profit multiples? AppFolio is a vertical market software business with best-in-class retention and strong pricing power potential. Ultimately we believe the primary determinant of vertical SaaS margin tends to be retention and pricing power, and believe this clearly points to APPF beloning on the long list of players with similar characteristics that have ultimately achieved EBIT margins in the 30-50% range. There is also significant financial sponsor activity at significantly higher multiples for businesses that we think are inferior to AppFolio (incl 9x TTM revs for RealPage).
-Ongoing growth in units
-margin stabilization and expansion
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