SmartRent (SMRT) Brief Analysis and Updates

 

Business Description

SmartRent is a company that provides physical access solutions to rental housing and for a small part, pending-for-sale housing. Brad Thomas has a great article describing it on 2023/06/01. It manufactures smart locks and builds the management software for it. On one hand, SmartRent sells the hardware to rental unit owners. On the other hand, it has a recurring revenue stream from the management software.

The access business includes self-guided tour service used by homebuilders or landlords for their prospect buyers and renters.

Hayden capital mentioned the company in its 2022 Q3 letter which has an extensive analysis on the stock.

SWOT analysis

Strengths

• Lucas Haldeman is the founder & CEO at SmartRent. He served as the Chief Technology and Marketing Officer of Colony Starwood Homes. From SmartRent's website, "[t]he custom platform developed by Mr. Haldeman and his team were instrumental in cost effectively helping the business acquire, renovate, lease and manage more than 40,000 single family homes in 12 states." He is definitely experienced in this niche space.

• Not only does the management have a rich background in the real estate industry, SmartRent had raised funds from RET Ventures before. RET Ventures investors own and manage over two million multifamily and single-family rental units across the U.S. and Canada. They include Starward Capital, Aimco, Essex, Mid-America, Invitation Homes, Venterra, etc. That connection gives SmartRent ready customers to grow for a very long time.

• Customers generate high ROI on investing in the system sold by SmartRent.

• Customers are sticky, very unlikely to churn due to the small cost to maintain the status quo once the system is installed. Switching to another system will incur a substantial cost without much benefits.

• Being in a niche market, its competition is limited. There is not enough revenue for multiple players and the business is not very exciting given a lot of on the ground work needed. The company does not have to invent very hard because its customers will simply let the company know about new requirements, and the new requirements are usually not hard to implement.

Weaknesses

• It's not profitable in 2023. It's also burning cash.

• Being a small hardware company, it's subject to supply chain issue which can affect its profitability and increase cash burn for the short-term.

• It can have difficulty raising capital given its low stock price and it does not have positive cash flow.

Opportunities

• The business model is sound. The company will break even at EBITDA by the end of the year. There is a high probability that the company will start to be cash flow and earnings positive in 2024.

• Its existing customers are large enough to provide substantial units for SmartRent to grow its business. SmartRent has 496 customers with over 6.5 million units as of March 31, 2023.

Threats

• Security breach may lose SmartRent's customer confidence with the company's products.

• RET Ventures exited of the SmartRent investment, and DeRose-Wilson Isaiah  (CTO) sold 93% of his stake on 2023/06/16 are red flags that things might not work out for SmartRent. The security concern raised by Bleecker Street Research may be a real threat. 

Updates

2023/11/27 Hayden Capital in defense of SmartRent

It's in Hayden Capital's 2023 Q3 letter. It has some answers to Bleecker Street Research's points:

Bleecker Street Research's point

Hayden Capital

SmartRent’s former largest investor, RET Ventures, is a VC fund. 60% of SMRT’s revenue last year came from RET Ventures portfolio companies. In Q2’23, RET Ventures sold its entire stake in SmartRent. Subsequently, new orders collapsed 66%. We have learned that SmartRent’s products were optimized to be sold to RET Ventures LPs, and with this circular demand now removed, look out below.

SmartRent restructured the sales & account management KPIs to give greater emphasis on increasing existing customer lifetime values (add-on products, raising software ARPU, etc.) instead of unit growth.  SmartRent already counts 15 of the top 20 real estate owners as customers. Each of these customers own ~70,000 units on average. Meanwhile SmartRent has another 573 customers, who own ~5.9M units between them. This equates to an average ~10,000 units each11. By definition for SmartRent to grow from here, they’ll have to penetrate further into this “long-tail” of US real estate owners. The problem is whether selling to a 70K unit owner or a 10K unit owner, the marketing costs are the same. A sales representative needs to devote ~6 months – 2 years of their efforts, launch pilot deployments, multiple meetings, etc. before the owner is usually comfortable signing on for this new product. But this cost is amortized across fewer units for incremental “long-tail” customers. The shorts point to RET Ventures exiting SmartRent stock as a sign that these customer relationships are at risk. But the fact is that the shares weren’t sold, but rather distributed to their LPs in-kind. RET’s venture fund was simply coming up towards the end of its life. These distributions have been going on since two years ago, and just finished in February (LINK). These LPs are the same customers of SmartRent, and are now direct shareholders. Second, I posed this question to Lucas when we met, and he responded that none of RET’s LPs have cancelled, or even shown any indication of wanting to leave. In fact, they continue to sign up new units for deployment.

Hayden also had a few more points:

• The company is also becoming more asset-light, by working with ADI Global as their primary distributor (LINK). This is set to free up at least ~$20M of capital for SmartRent, while putting the new customer sales function on ADI, which has a broader marketing reach with smaller real estate owners. 

• Since courting and servicing the long-tail customers has a lower return than the large early adopters, it makes sense for SmartRent to partner with a distributor that has the scale & willingness to do so. In addition, SmartRent also started allowing smaller owners to “self-install” the product in their units, thereby saving on installation & labor costs.

• These changes are already having an impact. Just last quarter, the company was able to free up ~$21M in working capital12. Additionally, SmartRent stated that this benefit does not take into the ADI deal, but rather only from improvements in their internal demand forecasting. These changes are significant for a company that has an enterprise value of just ~$380M.

• A few weeks ago, the company officially confirmed that they’ll be EBITDA positive in the fourth quarter, and plans to generate free cash flow early next year (LINK).

• All considered, it looks like SmartRent is on track to generate ~$35M in free cash flow next year, and over $50M in 2025. At those rates, the company would produce ~9% - 13% FCF yields, while growing software revenue at above 25% CAGRs in the medium term, with 0% historical customer churn.

• In fact, I wouldn’t be surprised if the company starts returning a portion of its sizable $210M cash balance (36% of its market value) to shareholders in the near term. When I asked Lucas about potential share buybacks recently, he seemed very excited about the idea. 

My takeaway:

• While Hayden Capital provided good answers regarding the demand from RET venture LPs, it hasn't adjusted the security part of the locks.

• Insider purchases from Strohm Bruce C (director, previously a General Counsel and Corporate Secretary of Equity Residential) and Best Robert T (director) were nice, I would like to see some purchases from the management to counter the scary sale from the CTO, DeRose-Wilson Isaiah , in June, 2023.

2023/09/09 comment on a short article by Bleecker Street Research

This piece has quite a few critical reasons which caused me to doubt of the future of SmartRent. I decided to pause the accumulation of SmartRent, and might even consider selling the position in the future.

Bleecker Street Research's point	My thought
SmartRent’s former largest investor, RET Ventures, is a VC fund. 60% of SMRT’s revenue last year came from RET Ventures portfolio companies. In Q2’23, RET Ventures sold its entire stake in SmartRent. Subsequently, new orders collapsed 66%. We have learned that SmartRent’s products were optimized to be sold to RET Ventures LPs, and with this circular demand now removed, look out below.	While I don't think SmartRent's products are so custom made to the investors of RET Ventures that they have difficulty in selling to other multifamily owners, it was real that their new orders booked plummeted in 2023 Q2. The management said it's just a delay in order, but I don't have confidence that it's entirely true.
SmartRent distributes and installs smart home systems, primarily “smart” locks, to large multi-family properties. SmartRent used a Croatian supplier that had a known security vulnerability. Instead of cutting ties with this supplier, SmartRent acquired it and changed the name of the products. FCC documents show that SmartRent still uses this formerly compromised supplier of locks from Croatia.	Security issues can be fixed, so this alone doesn't reveal much.
These security vulnerabilities have real-world consequences. An apartment in Alexandria, Virginia installed SmartRent locks. According to police reports, a man was able to open several apartments, eventually sexually assaulting one woman. This came after residents complained about the locks. A man was charged with intent to commit murder and rape after he was able to access these apartments. After this came out, SmartRent’s co-founder and Chief Technology officer sold 93% of his SmartRent holdings.	This is a big red flag for SmartRent's products. This is probably the biggest reason for me to lose the confidence in the company.
Former employees were more than willing to speak about the company, with not many saying flattering things. Several described the company as a “mess” with a “broken culture,” and one said that “how horrible it was” was the thing that stuck out the most about the company.	Every good company have disgruntled employees, especially the one who quitted. Not a big issue to me.
We will be posting part 2 of our story soon. It will contain more examples of how SmartRent’s locks have proven unsafe and their real-world consequences. We will also be further discussing SmartRent’s accounting and why we think there is a chance it follows fellow smart-lock company Latch into delisting and trading below net cash. For now, let’s focus on how SmartRent’s growth engine is broken, how its locks have caused tragedies. More soon…	I don't think accounting issues reveal any issues with SmartRent's fundamentals, but my confidence in SmartRent's security definitely dropped.

2023/07/06 comment on a short article by Night Market Research

There was a pretty good short report on SmartRent (SMRT) on Seeking Alpha: SmartRent: Accelerated Revenue Recognition For New SmartHubs Superficially And Temporarily Boosts Stagnating Low-Margin Business. While the reports have valid points, I do not think they show the fundamentals of the company are much different from what I accessed previously (you can also see it in the Brief individual portfolio holding comments section below). Here are the breakdowns with my thoughts:

Night Market Research's point	My thought
Accelerated revenue recognition for new hub version inflated 1Q23 revenue and full year guidance but has no effect on cash flow or profitability - underlying growth and KPIs remain weak	From the 2023 Q1 transcript, the management expects adjusted EBITDA breakeven in 2023 Q4, and cash flow will break even about 1-2 quarters after that. Cash flow is not affected by acceleration of accounting, which is most important for SMRT, as a lose generating company. For growth, SMRT has lumpy revenue growth because it's supply-constrained and the timing of deployment may shift a bit as well, especially for a small company like SmartRent. I don't worry much about it.
Bull case is based on SaaS segment generating less than 20% of total revenue. SmartRent is primarily a reseller and installer of third-party devices at thin gross margins.	My valuation assumes its hardware and professional revenues will only be profitable enough to cover the corp expenses. My earnings estimation is based on the profit from the SAAS segment alone. Because SmartRent's stock price is so depressed, it is trading at quite an attractive valuation under my conservative assumption.
Customers accounting for $105m (63%) of 2022 revenue are LPs in SmartRent’s largest investor. At end Q1, the investor no longer owns SmartRent, potentially cutting a source of incentivized demand.	The exit of the investment does not necessarily mean the customers will not work with SmartRent anymore. It's just speculation on the author's part. SmartRent's only competitor is Latch, which is in an existential crisis due to smaller scale. The fact that the article does not mention any competitions of SmartRent is a good sign.

2023/06/15 valuation

The company will earn between 225 to 250 million in revenue. However, in 2023 Q1, 57% of it is hardware revenue which has a very slim margin. About 20% from professional services which is a segment that loses money. If we assume its only profitable segment, hosted services, is 23% of the annual revenue, its revenue will be about $55 million. Let's assume that its hardware and professional services segments breakeven, including the cost of the corp, and SmartRent only has earnings with 75% profit margin from the $55 million hosted services revenue, the hypothetical earnings will be $41 million in 2023.

The current market cap is $650 million, so the "P/E" using this hypothetical earnings is 16. The host services segment revenue more than doubled last year, so it's pretty cheap if you go along with my assumption of its earnings potential.