AppFolio: With Simplicity, Comes Outperformance

Summary

• AppFolio builds a SaaS offering for only one market, which is the real estate. It has simple pricing, business model, and go-to-market.
• The simplicity of the business potentially drives the outperformance.
• Since the IPO in 2015, revenue and shares price have increased by over 3x and 10x, respectively.

Overview

AppFolio (NASDAQ:APPF) is an interesting investment opportunity in the SaaS real estate space. Revenue growth and OCF/Operating Cash Flows have been solid, while the business is profitable. Furthermore, the net profit margin has been in steady expansion as share price more than doubled over the last two years. The share price continued to trend upwards in 2020. It had a ~32% run-up to its YTD-high in February, right before the broader COVID-19 selloff. The stock has fallen by ~20% since then, which creates an attractive entry point to pick it up at a bargain.

Catalyst

In a nutshell, AppFolio makes money by selling an all-in-one cloud property management/PM software. To a much lesser extent, it also has a presence in the legal industry as it sells a similar software to the small law firm customers. This business is less successful and only makes up less than 10% of AppFolio's revenue. On the other hand, AppFolio's business as a whole has been exceptionally strong. Since the IPO in 2015, revenue has more than tripled, while share price has increased tenfold.

(Source: AppFolio.com/pricing)

We believe that the key to AppFolio's outperformance is the overall simplicity of the business. Given its focus on cloud-based PM software, AppFolio only needs to focus on one niche market, which is the real estate. The per unit/month pricing scheme is also straightforward and scalable for the customers. Moreover, simplicity would reduce the chance of making major execution mistakes. Consequently, the company's execution has been very solid. While top-line growth already decelerated to +36% towards the end of 2017 from +57% in 2015, the company has maintained growth in and around the +30% level as of the end of 2019.

The property management industry also provides an attractive upside, given the inherent digital transformation opportunity existing in any of the companies in the market. AppFolio's focus in this market has allowed it to broaden its offering to include tenant debt collection, renter's insurance marketplace, analytics, and AI through both organic and acquisitions over the last five years. All these solutions target the stakeholders across the property management ecosystem such as the tenants, owners, and property managers.

(Source: stockrow)

Over time, these activities have resulted in strong market positioning and economic moat. The business turned net profitable at the end of 2017, and since then, the net margin has expanded by over 750 bps. Moreover, shareholder value has also improved exponentially as ROE/Return on Equity grew by over 1,900 bps within the same period.

Risk

As per the Q1 earnings call, the outlook remains unclear, given the COVID-19 situation. While revenue still grew at 27% YoY, driven by the 18% increase in units under management in Q1, an overexposure to one sector can also amplify the risk. Over 90% of AppFolio's revenue is derived from its real estate PM business. Major property construction delays due to the continuation of COVID-19-related restrictions on business activities, for instance, will create a systemic contraction in demand for AppFolio's products.

Valuation

The stock seems expensive from the P/E perspective. It currently trades at 121x P/E, which implies that a growth expectation of ~120% is required to reach a fair value. At the moment, growth is still relatively very strong at +30% YoY. Moreover, the company's strong bottom-line, ROE, and cash flow generation easily explain the premium. Given the strong growth, it is also more relevant to look at AppFolio from the P/S perspective.

(APPF vs PAYC vs HUBS vs FIVN vs BL. Source: stockrow)

Among the other cloud software stocks with a relatively similar business model, growth, and size, AppFolio stands out. It is the fastest-growing and the only player aside from Paycom (PAYC) with a positive net margin. It is rare to find a profitable company growing at +34% that trades at ~14x P/S.

Furthermore, profitability and cash flow generation are also in upward trends as they improve every year. AppFolio is relatively in a flexible position as it plans its corporate strategy going forward to improve the already strong ~32% ROE. It can pay dividends, buybacks, or engage in more M&A deals. Having been down ~20% from its YTD-high where it reached ~18x P/S, the stock is a bargain at 14x P/S today.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.