Description

Company Name: SmartRent Inc. (SMRT)

SmartRent is the leading provider of smart home solutions for multifamily real estate owners and operators in the US.  SmartRent’s system is a home operating system which is centred on their own proprietary SmartHub device and is supplemented by an open ecosystem of third party devices. 

By providing the Smart Home Operating System SmartRent provides value to the multifamily landlords by:

1. dramatically lowering the landlord’s costs through efficiencies and damage prevention, and
2. increasing the landlord’s revenues through higher rents and other niche revenue opportunities.

SmartRent has three business lines:

1. 1. Professional services – SmartRent provides the labour to do the installations of the home operating systems.
   2. Hardware sales – SmartRent procures or produces all hardware used in the systems which are sold to the owners as part of the installation package.
   3. Hosted Services – SmartRent charges a monthly fee for the software services provided to use the home operating systems.  Hosted Services is by far the most important of the three businesses as it is where the vast majority of the profits are expected to come from.

I believe there is an opportunity for SmartRent to grab market share in a relatively new industry where the addressable market in the US is over 28 million multifamily apartment units and increasing.  SmartRent’s current customers own approximately 6.9 million units themselves.  The Hosted Services business is likely to be a sticky business with expected 70% gross margins at scale.  SmartRent’s share of the market is large and is increasing.  At approximately 1.6 million units installed and committed, SmartRent’s current number of deployed and committed units is only 5.7% of the total addressable multifamily market in the US and 23% of the units that their existing customers own.

I believe the key advantages SmartRent has to win this market are:

1. SmartRent has developed sales relationships with the vast majority of the largest landlords in the US (14 of the top 20 landlords are currently SmartRent customers).  As such many of them were early adopters.  This leaves a large pipeline of growth within SmartRent’s existing client base. 
2. The largest landlords also help as a marketing tool to bring on new landlords as they are seen as industry thought leaders.  As such, SmartRent’s dominance with the largest landlords helps them in acquiring the long tail of landlords (there are thousands of landlords who own 5,000 units or more in the US, so the industry is quite fragmented).
3. The SmartRent home operating system offers significant value to landlords in terms of cost savings and increased revenues.  The return on investment to the landlord can range from 20-50% on the initial capital cost and the ongoing monthly costs are far less than the additional revenues the landlord can earn from increasing rents.
4. SmartRent offers a complete turnkey solution in providing both the software system but also the third party and in-house hardware as well as the professional services to do the installation.  Being overstaffed hurt profitability in 2022 as supply chain problems led to working at below capacity, but SmartRent’s ability to ramp up installs is a key advantage over competitors who are trying to build out their own professional services offering.  In 2023 SmartRent has been more measured in taking on deployments and while that has hurt the number of deployments being done, it has helped greatly with profitability.
5. Significant switching costs once the system is installed as landlords will not want to use more than one software provider and they will not want to disrupt their buildings to replace the systems.

Investment Thesis

My investment thesis is that SmartRent will continue to scale up its Hosted Services software business over time which will allow for greatly enhanced gross margins on Hosted Services.  These high gross margins on Hosted Services will drive the profitability of the overall firm.

SmartRent has an existing backlog of 900,000 units that have been committed but have yet to be deployed.  In addition to this, the current customers of SmartRent own an additional 5.3 million units which have not yet been deployed or committed but likely will be in the future.  In addition SmartRent continues to bring on additional landlords. 

Given these factors, the growth pipeline for SmartRent appears to be mostly baked in already.  It will not likely be derailed by a recession either as landlords save costs with the system so they are just as incentivized to install them in good times as in bad times.

I believe the number of deployed units should grow steadily over the next five years and that will allow for greater operating leverage as the revenues within its Hosted Services division grow.  SmartRent should be able to achieve FCF margins of at least 15% by 2029.  Given the visibility on future growth over the next 5 years and the expected margins that should be achievable at scale, I believe an IRR of 26% is achievable over 5 years in my base case. 

In my bear case as detailed below, I estimate a 5% IRR.   As such I believe the downside to be relatively small relative to the upside and therefore I believe the outcomes to be highly asymmetric to the positive.

 History of the Firm

SmartRent was founded in 2017 by Lucas Haldeman who was the former Chief Technology officer at Colony American Homes (one of the largest multi family rental owners in the US).

After struggling to find a comparable technology solution to allow for more efficient property management, Haldeman decided to solve the problem himself and he founded SmartRent.

Since that time SmartRent has grown rapidly and has managed to sign many of the largest landlords in the US as customers.  SmartRent is a turnkey operation where they do the installations and provide ongoing services and this has resonated with many landlords.  They now have 680,000 units installed and deployed and they have a backlog of 900,000 units as well (both as of September 30, 2023). 

Products/Services

SmartRent provides smart home operating systems to multifamily apartment buildings.  Basic systems include:

• Smart Locks-Keyless Entry
• Smart Thermostats
• Sensors for water leak detection

The basic package allows for significant cost reductions in a number of areas.  Water leak detection is a major area where costs can be reduced.  70% of damage to multifamily buildings is caused by water.  Major repairs can often cost $500,000 or more.  By placing sensors near potential leaks, the system can alert property management of a leak before it spreads.  Upon detection of the leak, the software in the system automatically notifies property management and actually schedules a work order to fix the leak.

In addition to this SmartRent has a host of additional products and services including:

• Self guided tours for prospective renters

Prospective tenants can search available units online, and schedule a completely contactless self guided tour without interacting with any building staff.  The system will verify the identity of each prospective renter, and then grants a temporary access code to the renter to view a unit at the selected time.

This allows for greatly expanded times in which renters can view the units.  It also allows for greater capacity to see the units in prime time slots as it’s no longer limited to staff availability.

The system will also provide data and feedback to the landlord about the prospective renters, such as the amount of time the renter spent in the space and what amenities were visited.

• Community Manager

The system contains proprietary software which allows the landlord to easily enable customized settings for units.  For example, a vacant unit can automatically be put in “vacant mode” when a tenant moves out.  This removes all access from the locks, creates a work order for maintenance staff to turn over the unit, and automatically adjusts the thermostat down to save energy.

• Community WIFI

SmartRent’s hardware can run on a WIFI connection or on built in cellular data connections.  The WIFI coverage can then be offered to tenants for in unit use.

• Sightplan/Resident and Staff Management Software

Sightplan is a software operating platform that provides automated responses to tenant inquiries, field service and maintenance task management, inspections management, and due diligence and audit management services for landlords.

Residents can submit maintenance requests via a mobile app. 

Landlords can keep track of maintenance staff productivity by seeing in real time which tasks are completed, which units still have outstanding requests, and the amount of time the task has been outstanding.

Building staff can also communicate with residents directly in the app while also providing a recorded timeline.

The system also provides a streamlined building inspection process by providing a detailed checklist and audit trail of unit conditions, needed renovations/improvements, etc.

• Parking Management

The system provides integrated software and a database that allows landlords to assign and re-assign parking spaces, see in real time all of the parking space availability, monitor and validate authorized resident parking and also monetize extra spaces for guest parking.

Residents can get access to an online portal where they can add or remove registered vehicles and provide guests with parking access.

• Hardware

Hardware is mostly sourced from third parties with the exception of the SmartHub/FusionHub and the Alloy products.

Business Model & Unit Economics

The customers of SmartRent are the landlords who benefit from the system by reducing their costs, increasing their revenues, and thus greatly increasing the profitability of their rental properties.  Landlords can achieve an estimated 20-50% ROI on their initial capital investment.

SmartRent intends to make money mostly by continuing to add high margin Hosted Services revenue.  Professional Services and Hardware are operated more as pass throughs so that SmartRent can remove any friction or barriers to growing the higher margin Hosted Services business.

Because of the nature of the industry, landlords will usually prefer to use only one system in their properties and they will be unlikely to change the system once it is installed.  This means winning the initial business is crucial as the clients are likely to be long-lived with switching costs.

Increasing the scale of SmartRent’s operations should allow for a profitability inflection in 2024 as a higher percentage of revenue will be coming from Hosted Services.

It is possible that scale advantages will accrue to SmartRent in terms of data collection and R&D spend if they are able to obtain a dominant share of the market, but this is more speculation at this stage.

Sources of Competitive Advantages

1. Pre-existing relationships with large multifamily landlords and the industry recognition this provides as well as the existing pipeline for growth.  To replicate these relationships with existing customers would be difficult for competitors.
2. The system offers significant value to landlords in terms of cost savings and increased revenues.  The return on investment can range from 20-50% on the initial capital cost.  This value proposition will likely increase as SmartRent continues to roll out new products.
3. Once the system is installed, there are significant switching costs both in terms of actually physically changing over the system but also in re-training staff.  It is also unlikely that a landlord will use more than one provider as they would have to train their staff on two systems.
4. SmartRent is the only company who currently can provide the full turnkey system where they do the installation and provide the system.  Competitors are now trying to build out their own installation teams but this is not easy.  The full turnkey offering is appealing to landlords as they don’t have to manage the process and they reap the benefits.
5. It’s my belief that having the management team come from the real estate industry rather than from the software industry has been an important advantage for selling and deploying the system and is a source of competitive advantage.

 Industry & Competition

SmartRent’s competitors and potential competitors in the multifamily smart home market include:

1. Stratis (acquired by RealPage in 2020)
2. Yardi
3. PointCentral
4. Latch
5. Dwelo
6. IOTAs

The smart tech residential market is still very under-penetrated in the US.

It is likely that SmartRent will co-exist with a few competitors in the multifamily space as it is unlikely to be winner take-all or even winner take-most industry.

Stratis and Yardi are software providers who could prove to be formidable competitors if they are able to leverage existing relationships with landlords to offer multifamily property management software that competes with SmartRent.  However Realpage (Stratis) has been around since 1998 and has failed to gain real traction in the smart home operating system market.  They claim to have 380,000 units worldwide but I think there is evidence that this is overstated as only about 10,000 of these units are ongoing paying customers. 

One differentiating factor is that they do not do installations in-house and instead partner with the landlord’s developers or suppliers. This could lead to a worse experience for the landlord who has to source their own professionals to do the installations.

Still the breadth of Realpage’s service offering is a cause for concern as SmartRent cannot currently match all of their software offerings.

Yardi is private and currently provides software service to multifamily landlords.  They don’t have a competing smart home system offering but they do offer software solutions which perform similar or adjacent functions so there is a risk they could enter the space.

The other competitors are much smaller and less worrisome. 

Latch is a publicly traded company which appears to be in financial duress.  These financial concerns likely relate to its asset heavy approach which has proven to be too expensive.  Latch has also focused on newer building developments which have been stagnant recently.  Latch has failed to file their Q2 and Q3 2022 financial statements so they may be delisted.  They currently have 126,000 “spaces”.

PointCentral is the next largest competitor at 50,000 units.  It’s owned by Alarm.com (ALRM).  Pointcentral is primarily focused on vacation rentals and secondarily on multifamily.  They may be pulling back on multifamily based on their Q2 2022 earnings call where they indicated the multifamily space is pretty crowded already.

Dwelo and IOTAs are private and are smaller.  Approximately 40,000 units and 12,000 units respectively.

SmartRent has indicated that they believe they have more units deployed than the rest of the industry put together.  It is likely they currently are the leader by far in the space though as I’ve said there is a lot of untapped potential.

Customers

SmartRent is primarily useful for buildings that have more than 5 units (large enough to have dedicated building staff) and owned and operated by professional real estate companies.  There are approximately 28 million of these units in the US.

There will be limited concentration risk in terms of customers at scale because the largest landlords represent only about 0.5% of the total market.  SmartRent currently counts 14 of the 20 largest landlords as customers already. 

SmartRent’s existing customers own 6.7 million units which represents approximately 24% of the total addressable market.

Valuation

Base Case

SmartRent’s current market cap is approximately $640 million (as of January 30, 2024).  However SmartRent has net cash of about $211 million on their balance sheet for an enterprise value of approximately $430 million.  I think it’s likely that Smartrent will be profitable in 2024 and some or all of that cash could be returned to shareholders.  Management has made no public statements of their intentions but I think it’s reasonable to assume that stock buybacks could be in the cards.

If we assume that Smartrent can achieve overall FCF margins of 15% as Hosted Services ramps up by 2029, and if we assume a 15% revenue growth between 2024 and 2029, that gets us to about $70 million of FCF in 2029.  If we assume a multiple of 20 on that number you get to a market cap of $1.4 billion.  That would imply an IRR of 26% from today’s enterprise value or 17% IRR from today’s market cap assuming they don’t use their excess cash for buybacks.  15% FCF margins do not seem like a stretch when Hosted Services is expected to be a 70%+ gross margin business and will gradually become much more important than either hardware or professional services as they scale up.

A 15% growth rate also does not seem like a huge stretch given the amount of units that are owned by SmartRent’s current customers.  It is also likely that ARPU will increase as some of the sweetheart deals given to early adopters start to run off, and as SmartRent starts to layer on additional services like wireless internet and parking management.  If they were to grow the number of units they currently have deployed at a pace of 15% a year over the next five years that would still mean that they would not have worked through the 900,000 units which are currently committed but not deployed.  It seems unlikely to me that the pace of unit deployments won’t actually be faster than 15%.

Bull Case

If we assume the same 15% FCF margin but increase the pace of revenue growth to 20% we can get to a 22% IRR from today’s market cap assuming no buybacks and 32% from today’s enterprise value assuming they use their cash for buybacks.

Even if they just work through their existing backlog of committed units over the next 5 years, it translates to about 20% growth in units deployed.  Again I would assume their will be some increases in ARPU so arguably even this bull case is somewhat conservative.

Bear Case

If revenue growth is slower and if margins do not expand as quickly as I project in my base case, I still think it’s unlikely to experience a loss of capital here.  Even if growth slowed to 10% per annum and FCF margins only reach 10% by 2029, that would still imply a 5% IRR from today’s EV and -3% IRR from today’s market cap.  This seems like a stretch to me given the number of committed units in their pipeline.

I believe these scenarios to be a pretty conservative framework as:

1. It doesn’t account for interim cashflows between 2024 and 2029 which could be significant.  This is particularly true given that 75% of contracts are typically paid for upfront by the landlords.  The reason they do this is because landlords value their buildings based on Net Operating Income.  If they pay for the SMRT contracts upfront it doesn’t get calculated as an ongoing operating expense and as a result the landlord can report higher NOI and therefore higher property valuations.  As such SMRT has a negative working capital cycle.
2. The company currently has no debt and requires very little capital expenditures (about $2 million of PP&E on their Balance Sheet as of September 30, 2022).
3. I think it’s unlikely that the pace of unit deployments won’t increase at some point over the next 5 years to allow them to work through their backlog.  Since they are adding new units to the pipeline all the time, the actual units deployed could easily grow faster than 20% per annum and if ARPU is also increasing then it seems quite possible that revenue growth may remain well above 20% over the next 5 years, with positive flow throughs to margins as well.

Risks/Uncertainties/Reasons for Discount

I believe the main risk to my thesis will come from an inability to control costs and/or poor capital allocation.  The growth pipeline seems very baked in so I think it’s unlikely they will fail to reach our unit targets.

Competition could become more of a factor as they attempt to penetrate further into the long tail of landlords.  This is especially true where those landlords are already customers of Realpage(Stratis) or possibly Yardi.

A couple of short reports have also been published addressing security issues and a lack of commitment from some of Smartrent’s customers because of their sales of SmartRent stock. 

The security issues seem like a nothingburger to me.  When you have nearly 700,000 units deployed it seems unlikely to me that you’re never going to experience a break in or a malfunction.  The incidents reported in the short reports seem to be isolated incidents and it’s unclear SmartRent was even at fault. 

The issue over the share sales has largely been addressed in that the “sales” were from RET Ventures which is one of SmartRent’s investors and the shares weren’t actually sold but rather they were distributed to RET Ventures LPs.  Those LPs are actually SmartRent’s customers.  I think the slowing of growth we’ve seen in 2023 is not a function of lack of demand from these customer but rather a conscious decision by SmartRent’s management to slow the pace of growth in order to improve profitability.

Wage costs are likely to rise over time and the company has been overstaffed in the past two years.  We think this is appropriate given their position but controlling wage costs going forward will be a key challenge.

Marketing costs will also have to be watched closely.  It’s possible that SmartRent’s customer acquisition costs are temporarily suppressed as they are still working through some of the largest landlords portfolios, many of whom are shareholders of SMRT and were also given sweetheart deals.  SmartRent may need to spend more money to acquire the long tail of small landlords.

Long term the risk would be that the return on investment to the landlords somehow diminishes.   It is difficult for me to imagine a situation where the value provided does not justify the ongoing subscription costs.

I think the reasons for the discount in the price relate to the relative small size of the company and their unproven profitability in a tough macro environment in the past couple of years.  The stock price dropped significantly after the second quarter earnings were released on August 11, 2022.  This was largely due to the drastically reduced guidance on the number of units deployed and as a consequence the revenues for 2022.  The stock has remained pretty volatile in the past two years.

Catalyst

I believe that as the company progresses through 2024, they should reach an inflection point where Hosted Services revenues increase and thus overall margins will improve to the point where SmartRent as a whole becomes profitable.  We believe at this inflection point, the company’s share price should re-rate to reflect the diminished risk.

Long term the catalysts should be continued growth and increase in scale.  Important metrics to monitor will be:

1. Growth in ARPU
2. Growth in the number of deployed and committed units
3. Customer acquisition cost
4. Landlords’ return on investment