Almost all special purpose acquisition companies (SPACs) that went public in 2021 have been sabotaged. By November 2021, SPACs were down an average of 9.9% in price since their merger dates, and that doesn’t take into account the volatility of early 2022.
A SPAC that stood out during this withdrawal, however, was Latch ( LTCH -5.54% ). Latch provides smart locking technology to large-scale apartment buildings. He also owns a high-margin software business that allows landlords to monitor their apartments for safety and security. Latch’s impressive products haven’t immunized the stock against the downside, however: shares have fallen almost 79% from their all-time high reached in September 2021.
The company may have lost a small spark after it released its fourth quarter results on Feb. 24, which revealed some risks that could deter you from buying today.
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Another failed SPAC?
Many SPACs were known for their aggressive projections of future growth. SPACs – according to the Harvard Law School Forum on Corporate Governance – averaged an annual revenue growth rate of 116% when they went public.
These companies have gotten a little carried away in their growth estimates, given that many of them have not met these targets now that they are public companies. Latch is one of those overly optimistic forecasters. In 2021, the company had $41.4 million in revenue, but in its early 2021 SPAC presentation, it had estimated $49 million in revenue for that year.
Additionally, the company’s initial projection for 2022 revenue was $173 million, but in the fourth quarter the company lowered that estimate by 49%. He now expects just $75-100 million in revenue in 2022.
That wasn’t the only reason Latch shares fell following the release of fourth-quarter results. The company’s gross margin also declined sequentially. In the third quarter of 2021, the company’s gross margin was at breakeven, but in the fourth quarter it fell to -27.5%.
This decline resulted in earnings pressure for Latch. The company lost $54 million in the fourth quarter alone, which was up 181% year over year. The problem is, that net loss growth far outpaced its fourth-quarter revenue growth of 94% year-over-year. To make matters worse, its free cash flow burn in 2021 was $114 million. The company only has $284 million in cash and securities on the balance sheet to fund those losses, so if those continue to mount as they have this year, Latch could struggle to stay afloat.
A move to software
However, the news wasn’t all bad in the company’s fourth quarter. Latch announced a shift in focus to its software products rather than its hardware products. Its hardware — the company’s smart locks — accounts for the majority of Latch’s total revenue, but its margin on those locks is negative, while software revenue margin was 91% in the fourth quarter. Latch management indicated that it wanted to directly develop fewer hardware products and instead allow second- and third-party manufacturers to build the hardware with built-in Latch software capabilities.
This shift in business mix, in theory, will improve Latch’s margin profile and unit economics, which could reduce the company’s net loss and free cash flow consumption. On the other hand, the company will make less revenue from hardware products in the coming quarters, and software revenue only accounted for 18% of revenue in the fourth quarter, so this decision will also hurt the revenue growth of the company in the short term. This compromise explains the company’s disappointing forecast for 2022.
Another silver lining to the company’s fourth-quarter results is its bookings, which rose 113% year-over-year to $97 million. Latch’s reservations represent the apartment managers’ intention to use Latch’s hardware and software once the building is built. This strong expansion in reservations therefore shows that the company’s products are still in high demand.
Is Latch a buy?
This shift in focus could be what makes Latch a high-margin business, but it’s not without risk. This will likely impact the company’s revenue in the short term, and this business model has no guarantee of success. For that reason, along with worries about its free cash flow consuming and net loss rising, it might not be the best idea to stock up on stocks right now.
That being said, if you already own shares of Latch, you might want to avoid selling. The industry Latch is attacking is worth $54 billion a year in the United States – a massive opportunity that could expand if it succeeds internationally. This company is a long-term investment, but if it can manage to focus on software and improve its finances in the process, Latch has the potential to be an incredible investment. The company trades at 16 times its sales, which may turn out to be a bargain if you see it again in 20 years.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end consulting service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.
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