Description

Business Overview

Altus Group offers a suite of software, analytics, and services to leading commercial real estate (“CRE”)  industry participants. Formed in 2005 as a publicly traded income fund through the merger of three Canadian real estate consulting services firms, Altus is headquartered in Toronto and trades on the Toronto Stock Exchange. In 2022, Altus generated $735m in revenue (17.2% year-over-year growth) and $135.3m in adjusted EBITDA, and at C$49 per share currently trades at a diluted market capitalization of just under C$2.4bn (all dollars Canadian).

While real estate valuations are at the heart of all Altus service offerings, the company goes to market in three segments: (i) Altus Analytics (47% of revenue, 20.7% EBITDA margin in 2022) includes ARGUS valuation software, the industry standard for CRE financial modeling that allows institutional CRE investors to develop asset level and lease level cash flow projections. Also included within Altus Analytics are valuation management services (VMS), which are recurring, software-enabled third-party appraisals for CRE investment portfolios, as well as proprietary data analytics tools; (ii) Altus’s property tax business (37% of revenue, 32.6% EBITDA margin) serves CRE owners by providing independent appraisals to reduce taxes associated with higher property valuations passed on by local governments, with the bulk of segment  revenues generated on a contingency basis; and (iii) Altus’s appraisals and development consulting services (16% of revenue, 14.4% EBITDA margin) business provides more traditional consulting services, including appraisals, feasibility studies, and project management.

As a non-discretionary, competitively advantaged, and recurring business with high long-term margins, Altus exhibits the business quality indicators that we prioritize, while trading at an attractive valuation. Most importantly, Altus Analytics’ average contract length is three years and includes pricing escalators. Price is determined on a per seat basis for ARGUS and other data analytics software, and priced per asset per appraisal (e.g. annual, semiannual, quarterly) in VMS. Property tax engagements are largely recurring and countercyclical, providing real estate asset owners the ability to reduce their single largest annual cost (property tax), with greater potential savings during market pricing downturns. While Altus’s smallest segment – appraisals and development advisory – exhibits some cyclicality, appraisals are primarily recurring, and development consulting contracts are often signed on a multi-year basis.

Company Background

Altus’s ARGUS software is now in the sixth inning of its transition to cloud after beginning the development process in 2018 and discontinuing its on-premise offering for new license sales in early 2020. Cloud licenses provide a 30-50% annual price uplift over on-premise maintenance fees, boosting Analytics segment revenues, which have grown at a 15% revenue CAGR since 2017. Early transition stages were painful from a research and development duplication of effort perspective, and Analytics EBITDA margins peaked at 28% in 2017 pre-transition, troughed in 2021 at 17%, and have since rebounded to 20.7% in 2022. On a single, extensible development platform, management expects Altus Analytics EBITDA margins to exceed 35% at maturity.

We invested in early 2021 based on the belief that Altus Group’s new management team was well-suited to execute the cloud transition and maximize the value of its underlying data assets. At the time, since-departed CEO Mike Gordon had recently been appointed (September 2020). Gordon was previously CEO of Callcredit (leading its sale to Transunion for $1.4bn in 2018) and was an SVP of sales at FICO before that. Joining Gordon as President of Altus Analytics and now CEO of Altus was Jim Hannon, (previously CCO of Callcredit and VP of Business Operations at FICO) and now Chief Product Officer Jorge Blanco (also ex-FICO). At Callcredit, Gordon and Hannon successfully executed a series of tuck-in acquisitions, monetized their data assets by bundling benchmarking data with subscription sales, and added new products, ultimately generating a 2x MOIC for private equity owner GTCR. In a 2020 conversation with previous CEO Gordon, we received an early preview of Altus’s long-term data monetization strategy that is currently materializing today, saying that he said he was attracted to the opportunity at Altus because “Altus is in the early innings of a long-term journey similar to the one that FICO went through – both Altus and FICO came from services and there’s a long-term opportunity to leverage the trusted services relationship into highly profitable analytics to become the industry benchmark data.” Gordon stepped down from Altus in early 2022 after receiving an offer that he “couldn’t refuse” to become the CEO of Aris Global, a pre-IPO life sciences software company in Boston, his hometown. Gordon remains on Altus’s Board of Directors. We have consistently found new CEO Jim Hannon to be a non-promotional, operationally focused executive who ranks high on the humility scale. Since joining Altus in 2020, Jim has more than doubled Altus Analytics annual new bookings, implemented a new ERP that went live in Q1 of 2023, implemented Salesforce CRM (going live in Q2 of 2023), reduced costs in both the property tax and appraisal advisory businesses, reorganized tax and appraisal consulting to incentivize recurring software and analytics sales, and consolidated Altus’s underlying tech stack to enable a unified taxonomy across datasets. In short, we find the performance of the management team highly impressive. Incentive compensation for Hannon and Blanco is based primarily on total shareholder return relative to its peer group on an annual and three-year rolling basis, and both executives receive no performance stock unit compensation if shares lag peers by more than 25%.

Altus shares declined more than 20% in mid-April following the announcement of its first quarter earnings results, with shares reacting to disappointing new bookings performance (down 24% vs prior year) in Altus Analytics. Results were impacted by a pause in CRE fund purchases on the heels of the collapse/failure of Silicon Valley Bank (“SVB”), Signature Bank and First Republic Bank, along with investor concerns over expected declines in commercial real estate prices. Based on the magnitude of the share price decline relative to otherwise fine results, we believe investors misunderstand the drivers of Altus’s revenue model. Altus’ revenues have no direct linkage to real estate prices; rather, appraisal revenues are driven by the number of assets on the platform and appraisal frequency, which is likely to increase during periods of valuation uncertainty.

Altus shares bounced back 16% following 2Q23 earnings, in which Altus Analytics recurring bookings rebounded sharply (growing 8% YoY on a tough compare), Altus Analytics revenues and margins significantly exceeded consensus estimates, and Altus put up a blowout quarter in property tax appeals revenue, which grew 19% YoY excluding the impact of 2023 U.K. annuity appeals revenue (2023 is a reset year on a 3-year rolling schedule, as discussed later in this post). Even after 2Q results, we believe Altus shares can generate high-20 percent returns from current levels over a three-year time horizon assuming a conservative exit valuation.

Altus is also an underfollowed, relatively illiquid stock (~$5m/day) with no US analyst coverage and minimal market recognition of company’s pivot to software & analytics due to its long history as a real estate services company. In fact, depending on the source, the company is still classified at the sub-industry level as anything from a real estate holding and development company to a management consulting service.

Investment Thesis

1) ARGUS is a crown jewel business with a dominant position in CRE valuation software and significant network effects, enabling better monetization as the company completes its cloud transition

In Altus Analytics, ARGUS valuation software has no notable competitor of scale besides Excel and has 73% market share among Top 200 CRE investment managers. Per a senior executive at CBRE group, “We don't even really have an option, in most cases, to not use it. The vast majority of the work we do and the clients we serve are larger pension funds, other private equity investment groups, REITs, who all would have that requirement. Many of the lenders as well, if you're doing something for financing, would require that as well. Basically, the only time we wouldn't need to use it would be if you're doing something very small-scale, very simple, that you would be able to do in Excel.”

The CRE industry has aligned on ARGUS as the standard modeling tool, and ARGUS valuation models are shared internally and externally as common parlance for asset valuations. ARGUS’s network effects have only strengthened with ARGUS being taught at 200+ leading educational institutions (e.g., MIT's real estate program), creating a virtuous cycle with regards to talent acquisition, and being written in as the default valuation file format in engagement letters for global brokers. We reviewed a demo during our diligence process and found the tool flexible enough to provide utility in one-off projects and powerful enough to review performance at the portfolio level. Additionally, our due diligence, including website scrapes, validated the company’s market share as ARGUS is mentioned 8x more often than its nearest startup competitors globally. ARGUS software’s mission-critical nature is reflected in its 95% average gross dollar retention over the last three years and 97% in the last year. To-date Altus has primarily monetized ARGUS through on-premise to cloud license upsells and user count expansion, and has significant latent pricing power.

2) Altus Analytics can become the “Bloomberg of CRE” by monetizing its singular asset-level dataset

Within Altus Analytics, ARGUS, VMS, and other analytics products combine to provide asset-level data for over 53m properties and over 10m models with cash flow forecasting and valuation detail. As a result, Altus has a natural long-term opportunity to monetize its trove of customer data through real-time data insights and benchmarking products, an opportunity we size at $1.5bn. There are multiple parallels illustrating the demand for differentiated asset-level data. With detail at the cash flow level, Altus’s insights on market conditions, rents, and valuations, compares quite favorably, to highly valued Costar Group (CSGP), which has built a large subscription data business (in part) on reported transaction multiples in local markets. Notably, Costar trades at 10.5x EV/fwd revenue and 48x EV/fwd EBITDA, more than triple Altus Group’s valuation.

Completing the unification of its Altus Performance Platform near the end of 2022 has allowed Altus to launch its new Market Insights premium offering. Market Insights enables clients to pull in anonymized data from Altus’s platform into the client’s dataset and provides an outsourced offering in which clients conduct studies using Altus’s proprietary dataset. While early days, we view this offering as a first step in monetizing Altus’s valuation data across offerings to help clients enhance portfolio performance, make better investment decisions, and optimize taxes, generating high-margin, recurring revenues for Altus in the process.

Management’s initial guidance for 2023 called for 300 bps of margin expansion in Altus Analytics, a more muted improvement from 2022’s 410 bps expansion, as management expected to invest aggressively in sales and marketing headcount. Since SVB’s collapse in late March, our monitoring of headcount data suggests that the pace of hiring at Altus group has fallen significantly. Recent discussions with management imply that they believe they could improve Altus Analytics EBITDA margin by ~700-1200 bps (midpoint yields a 30.5% EBITDA margin in 2023) if it were not making discretionary go-to-market investments that they consider to have strong long-term economics. We think that management is exercising prudence with respect to sales and marketing hiring to the benefit of near-term margins. Over the long-term, we believe Altus Analytics EBITDA margins will approach 40% based on the strength of its position in ARGUS, additional contribution from new, high-margin cross-sales of data and analytics packages, and structural sales and marketing benefits as a vertical software player catering to a targeted segment of customers.

4) Altus is still valued as a services-first company despite rapid transition to software and analytics

At C$49 per share, Altus Group trades at 13x our projected 2024e EBITDA(adj.) – Capex, or 19x AltusAnalytics standalone EBITDA (adj.), while still highly inexpensive relative to comparable U.S. peers,

implies zero value for property tax, appraisal and development advisory, and unallocated G&A costs, whichtogether project to $88m in 2024 adj EBITDA. Based on conservative, below-market and peer multiples,our sum of the parts analysis arrives at a $75 price target, implying 53% upside from the current share price.

Catalyst

U.S. listing

Sell/spin of divisions

Continued transition success

CRE bounceback