APPF - AppFolio: Attractive AI And Real Estate Buy

2023-10-20 09:54:29 ET

Summary

• AppFolio is a cloud software platform operator that specializes in modernizing the real estate property management industry.
• Its focus on improving operational efficiency for property management firms as well as driving payment volumes from residents enables a diversified revenue stream.
• We believe the company is poised for growth, driven by its strong technology capabilities and expansion in the SMB segment.

Investment Thesis

We initiate AppFolio ( APPF ) with a Buy rating and ascribe a target price of $210 (at 9.5x EV/ 2024 Revenue). We believe AppFolio is deeply integrated within the entire real estate cycle offering property-specific solutions to property management firms to drive operational efficiency as well as to residents with a focus on ease of payment. Its strong AI capabilities along with technological advancements making it easier for non-savvy technical people is likely to drive growth within its key focus areas of the SMB segment as well as the upmarket segment. In addition, it has strong industry tailwinds considering strong growth in new units addition within the overall US real estate as well as higher occupancy rates. We believe the company is perfectly poised to capture further growth within the growing property management space.

Company Background

AppFolio is a leading cloud software platform operator providing solutions to modernize the real estate property management industry. It offers platform solutions that help property management customers increase their operational efficiency and also enable an improved digital experience for the residents. It boasts a total of over 19k customers which manages a combined 7.7 mn units through its platform. It operates on a subscription-based model offering Value+ services sold to property management firms with fees varying by property type and contracts with a duration of up to 1 year. Services offered include screening potential tenants, sending and receiving payments, and providing insurance. It also generates revenues from payments done by the residents through the platform.

Attractive Exposure to US Real Estate

The property management industry performs well during inflationary times as rents go higher, with fees tied to rents, along with higher occupancy rates. In addition, labor shortages coupled with higher wage inflation have led to an increase in demand for software applications as firms run small teams of employees while lowering payroll, property and maintenance expenses. Considering the top multi-family REITs, property and maintenance and property management expense forms the bulk of operating expenses which are controllable while real estate taxes and related costs are essentially non-controllable. Taking a look at a few of the multi-family REITs, Equity Residential ( EQR ), AvalonBay Communities ( AVB ), UDR, Inc. ( UDR ), and Mid-America Apartment ( MAA ), property maintenance, management and repair forms about 50-60% of total opex and management views it as an attractive prospect to curb costs and look for better operational efficiency.

We believe a lack of comprehensive property management-specific cloud solutions for small and medium businesses as well as upscale residential customers in the US provides an attractive expansion opportunity. Out of a total 325k+ property management firms in the US, AppFolio serves about 19k (~6% market share) providing a significant opportunity to expand. The company views a TAM of 51 mn units combined with 28 mn community association units with further potential to expand further compared to its exposure to under 8 mn units currently.

Robust Track Record

The company has reported strong growth in total unit addition historically with total units growing over 17% during the 2017-2022 period. It added about 5k customers during the same period while growing its average revenue per unit (ARPU) which grew over 8% during the period leading to a strong 27% revenue CAGR during the past 5 years.

Note: Q1 and Q2 2023 ARPU calculated on a TTM basis.

In addition, it has consistently grown its pie of revenue from the payments done by residents on which it charges a small fee. Residential revenue from the residents has grown to an estimated 40% driving a diversified revenue stream across the real estate lifecycle. APPF generates higher margins with customers opting for different payment types as credit card generates lower margins compared to ACH, however, the firm is focused on increasing tenant engagement and growth in payment volumes.

Technological Advantage (AI+)

We believe AppFolio's technology is ahead of its competitors driven by seamless integration across all its products and platforms. In comparison, large competitors have products that are not seamlessly integrated as most of them have been grown through acquisitions compared to organic growth of AppFolio. AppFolio has single-tenant cloud-only platform operated through AWS public cloud that allows the company to launch AI solutions which can be easily used by the non-savvy tech customers. Its AI leasing assistant, Lisa, and is used for onboarding and is able to schedule room viewing without any human intervention. In addition, APPF has been working on AI to apply machine learning in every workflow and has been rolling out several solutions such as Smart Bill (scanning a bill and entering accounting ledgers for customers), Smart Maintenance (prioritizing urgent customer needs for maintenance without any human intervention) and Smart Insurance (checking a valid insurance of the customers). The company has also been applying AI in the bank feed since last year which provides bank reconciliation matching transactions in bank accounts with the accounting system. We believe the company's investments in developing affordable housing solutions along with bolstering AI capabilities would enable them to continue leading their technological prowess compared to other competitors.

Expansion in Upscale Segment

Short-term rental continues to grow by robust double-digit growth as available listings grew 15% YoY with total demand up 12% through September where the market grew 23% in 2021 and 18% in 2022 . The market is also poised to grow double digits as a result of increasing night rates with a slight decline in occupancy. Some customers only use properties for short-term rentals for leisure or vacation, while others look to convert the property into long-term rental. The flexibility is essentially important for upmarket clients and APPF's strong positioning in the segment with several new services launched such as loan tracking, cost centers, and project budgeting along with report builder services offering customized reports is likely to add to the expansion within the growing upmarket segment.

Growth Outlook

Management expects 2023E revenue to be ~$595 mn, growing 26% YoY, up from $575 mn it was expecting at the start of the year driven by strong growth in both unit addition as well as ARPU growth. In addition, it expects a non-GAAP EBIT margin of 6% along with an FCF margin of 6.5% driven by strong H1 and continued earnings momentum. We believe the growth is likely achievable as a result of net addition in total customers as well as total units (it added ~1 mn units in 2021 and 2022 and ~400k in H1 2023) and believe 2023 could be another year of an ~1 mn in net unit addition. We further expect 2024 revenues to grow by about 30% on top of strong growth in 2023 driven by high-single-digit growth in ARPU along with high-teen growth in unit additions.

We expect EBITDA margins to expand substantially growing to ~15% driven by SG&A leverage and lower marketing spends as % of revenue due to revenue growth outpacing fixed cost and marketing spends along with stable gross margins at 60-62%. This would essentially lead to drive strong free cash flow generation with FCF margins expected to grow to low double digits and further potential to improve thereon.

Competitive Landscape

RealPage and Yardi are amongst the biggest players within the property-based SaaS space forming the bulk of the market share. RealPage serves about 20 mn units in the US with a presence across South America, Europe, and Asia. It has significant exposure to the upper end of the market including several corporate clients but also has exposure within the SMB segment through its acquisition of Buildium. In addition, Yardi is another large platform with a focus on large corporate customers but also has a 'Breeze' division which provides services within the SMB segment. We believe AppFolio's expansion within the growing SMB space and which is not of a central focus to the large competitors will lead to a growth in its market share. In addition, AppFolio platform enables leasing, maintenance and accounting all in a single platform while the competitor platforms require them to log into different platforms which can be cumbersome.

Valuation

We value APPF on DCF as well as relative valuation basis. On DCF basis, we assume a Cost of equity and WACC of ~11% as the company has no debt with perpetual growth rate of 2%.

Assuming a unit net addition to grow at 15% CAGR during the 2022-2023 period and ~8% growth in ARPU which seems reasonable given the track record of the company and strong opportunities within the industry, we estimate revenue to grow by ~24% over the next decade. We further assume operating margins to expand substantially to 35% driven by operating leverage and lower marketing spends as APPF becomes the go-to player in the market. We estimate the present value of the shares to be $215 discounting the FCF to present value.

On a relative valuation basis, we compare APPF with other SaaS-based players. Applying the multiple of 9.3x EV/ 2024 Revenue in line with the peer average, we value APPF at $206. Applying a 50-50% weightage to both DCF-based valuation and relative valuation, we ascribe a fair value of $210, implying a 15% upside to the current levels.

Risks to Rating

Risks to rating include:

1) APPF has higher exposure to the SMB market and a prolonged challenging macro backdrop could lead to reduced spending ability of the SMB customers.

2) Management's growth via the inorganic route is poised with executional risks as witnessed historically where in AppFolio entered into the legal market in 2012 and utilities market in 2018 to grow in adjacent market of the real estate, both of which were unsuccessful and was subsequently sold at a loss.

3) Its exposure in the technology segment is inherent with fast changing technological landscape and competitors can come up with revolutionary technological advancements which can make their technology obsolete.

Final Thoughts

We believe AppFolio is perfectly positioned at the intersection of the growing rental market, rising rents, and reducing costs for property management firms. Its breakthrough technology and AI capabilities have led to a strong unit addition historically which is poised to grow further. In addition, its exposure to a fragmented but growing SMB space is likely to drive growth while its improved service offering within the upmarket segment will also aid in incremental growth. We initiate at Buy ascribing a target price of $210 which implies an EV/ 2024 Revenue of ~9.5x.

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