Should IoT Investors Buy Alarm.com Stock?
This past year, we’ve methodically gone through each of the twelve themes we cover to decide which stocks and ETFs we want to hold in our own Nanalyze Disruptive Tech Portfolio. More recently, we’ve been exploring the Internet of Things (IoT) theme which is slim pickings. The only IoT ETF out there doesn’t mesh well with our current portfolio, and there aren’t many pure-play stocks aside from a handful we found in the smart home space.
Alarm.com Stock and Smart Homes
In our previous article on 4 Pure-Play Smart Home Stocks for IoT Investors, we talked about how there’s plenty of growth left for smart homes. Only 16.66% of homes in the U.S. and Canada are smart homes, and that number falls off a cliff when you look outside North America. Of the four stocks we looked at, only one merits a closer look – Alarm.com (ALRM).
Just days ago, Alarm.com set new 52-week highs as they released earnings which surpassed expectations. For someone who is thinking about starting to accumulate a position in Alarm.com, that’s not good news. Still, what we need to decide today is if we want to start accumulating shares of Alarm.com in our own portfolio. It’s one of two stocks we’re now seriously considering holding, the other being a mysterious remote connectivity stock we’ll discuss next week. Let’s start by seeing if Alarm.com satisfies the basic criteria defined in The Nanalyze Disruptive Tech Investing Methodology.
Alarm.com’s Revenue Growth
The most important thing we look for is revenue growth. You aren’t disrupting anything if your revenue growth is flat. In the case of Alarm.com, we see revenue growing consistently over time at a compound annual growth rate (CAGR) of 25% over the past eight years.
For 2019, those revenues were segmented into 67% software-as-a–service (SaaS) and 33% hardware. Ideally, we want the SaaS segment to comprise a large majority of their revenues. Should a recession hit, and people stop buying fancy hardware for their McMansions, that high-margin SaaS revenue stream will help Alarm.com weather the storm. (Alarm.com service provider partners typically have three to five-year service contracts with their subscribers.)
Speaking of storms, the Rona hasn’t had much of an impact on Alarm.com. One reason investors applauded the recent Q3 2020 earnings report was that Alarm.com revised their guidance upwards. In other words, they did better this year than they originally anticipated. This could be because some Americans think their society is so civil they no longer need bobbies on the beat, and homeowners are taking precautions in case that idea goes pear-shaped.
Unlike their peers, Alarm.com’s management team has shown they can grow their business without incurring large amounts of debt. What we want to look at next is the company’s bigger picture strategy.
Alarm.com’s Growth Drivers
Looking at a company’s investor deck helps us understand their strategy. Alarm.com describes their market opportunity as “the global smart security market” which is forecasted to grow at almost the same rate as Alarm.com’s revenues have been growing – a CAGR of +24%:
Further down the deck, the company talks about growth drivers which include increasing their subscribers and service provider partners. Additionally, they list the following four drivers of growth:
Let’s go through each of these growth drivers.
Upsell and cross sell existing subscribers
When evaluating a SaaS business, we refer to the revenue stream as the “run rate.” Run rate falls when you lose a customer, or a customer spends less on your products. For 2018/2019, Alarm.com had a renewal rate of 94%, which seems good when you consider how competitive the smart home space is.
In order to increase their run rate, Alarm.com can:
- Increase prices
- Add new subscribers
- Sell existing subscribers more stuff
Since the service providers are selling the product to subscribers, Alarm.com doesn’t have direct control over the upselling that takes place. What they can control are the product offerings they’re building or acquiring that can be sold to existing customers. For example, this year they introduced the Smart Water Valve+Meter to help people avoid billions in annual property damage loss from water leaks and use water more efficiently. This brings us to the next growth driver – growing verticals.
Over the years, Alarm.com has been making selective acquisitions and establishing subsidiaries that operate as verticals. Let’s take a closer look at three of them.
Distributed energy resources (DER) is a term used to describe energy generated and management by homes or businesses that’s “behind the meter.” For example, rooftop solar, battery storage, thermal energy storage, electric vehicles and chargers, and smart meters all allow a two-way communication between the grid and the customer using DER. Since electricity is priced differently based on availability, DER allows customers to use less electricity during peak, or even sell energy back to the grid. One study found that investment in DER could reduce network expansion costs by nearly 60% by 2050.
Powered by machine learning algorithms, EnergyHub’s DER Management Solution (DERMS) called Mercury is the most widely used DERMS in the industry, with 40 utilities using the platform to deliver load shifting and renewables matching, solar inverter management, peak demand reduction, and more. EnergyHub manages the largest portfolio of customer-owned DERs in the United States, and their platform is available to 25% of U.S. homes.
PointCentral is an enterprise-strength platform that enables vacation rental and residential property managers to remotely control energy and access to all their properties from their desktop or mobile device. Property managers can control property access, improve security, and save 10% to 20% energy costs annually. Says the company, “due to high demand, potential customers who manage less than 25 housing units are temporarily on hold until we can work through our current backlog.” That’s a good problem to have.
Building36 targets heating, ventilation, air conditioning (HVAC), plumbing, and electrical trade companies that want to make the homes they work on smarter. Alarm.com’s investor deck emphasizes the work they’re doing around modernizing HVAC in particular. For example, they’ve developed AI algorithms that monitor HVAC units to proactively detect trouble conditions before they escalate and lead to higher costs for repairs or failures.
Alarm.com continues to make acquisitions, with the most recent being a firm called OpenEye which aligns with their next goal – to grow enterprise, video, and access control.
Alarm.com plans to “grow adoption of video,” which helps explain their acquisition of OpenEye last year, a leading provider of cloud-managed, video-based security solutions for the commercial market. More than 400 active service providers manage OpenEye deployments in over 15,000 locations.
While the acquisition of OpenEye furthers Alarm.com’s expansion into enterprise markets, they’re now competing with some formidable competitors in the cloud video space. For example, earlier this year we wrote about Verkada’s Smart Security Camera System for Smart Cities. The company claims it has more than 2,500 enterprise customers since it launched commercially two years ago, including 25 global Fortune 500 companies. Then there’s Ambarella (AMBA) with a global installed base of over 750 million security cameras. They’re now developing computer vision that operates at the edge, meaning tomorrow’s security guard may be an AI algorithm. Then there’s Eagle Eye Networks which closed a $40 million round of funding a few weeks ago to build out their cloud-video surveillance offering. Cloud video is a high-growth area, and plenty of companies have taken notice of that.
For any business, it’s a risk to be overly dependent on a single country for revenues. Alarm.com has plans for international expansion, but things are going slowly. Below are the percentage of revenues for Alarm.com that come from outside North America:
- 2017: 1%
- 2018: 2%
- 2019: 3%
It’s an easy metric to track so we can monitor how this growth driver progresses.
It’s important to identify red flags, no matter how small. Looking through Alarm.com’s 2019 10-K raises a few small concerns.
The first thing to note is a number of lawsuits Alarm.com is engaged in relating to intellectual property. One lawsuit was brought on by Vivint in 2015, and the other by EcoFactor in 2019, the latter of which relates to Alarm.com’s smart thermostats. More color on both of these lawsuits is expected in 2021. The larger a company grows, the more likely they’ll be dragged into a courtroom to defend themselves. In both cases, Alarm.com states that “a loss is not probable or reasonably estimable at this time,” guidance that’s not particularly useful.
Let’s look at the below statement found in Alarm.com’s 2019 10-K:
During the years ended December 31, 2019, 2018 and 2017, our 10 largest revenue service provider partners accounted for 52%, 57% and 60% of our revenue.
While it’s less than optimal that half their revenues come from just 10 service providers, that percentage is decreasing over the years which bodes well. Then there’s this statement:
ADT LLC represented greater than 15% but not more than 20% of our revenue in 2017, 2018 and 2019.
We talked about ADT (ADT) in our previous piece on four smart home stocks, noting that they have a special relationship with their competitor, Alarm.com. That agreement was amended just days ago to define the terms of the relationship now that Google has gotten into bed with ADT. You’ll need to wait until Alarm.com files their 10-K for 2020 at which time they’ll attach the updated agreement for your viewing pleasure.
Certain cellular carriers have announced their intention to shut down their 3G and CDMA wireless networks by the end of 2022. Alarm.com doesn’t go so far as to estimate the costs this may incur, but they do acknowledge this as a risk. When looking at their competitors, we noted one had allocated several hundred million dollars to the transition. Given their positive cash flow and $250 million in cash on hand, any costs to transition Alarm.com’s clients away from 3G should be manageable.
There’s a lot to like about Alarm.com’s ability to grow revenues, their resilience in today’s pandemic, and their expansion strategy. There are some small red flags, but nothing that can’t be managed. Plenty of bolt-on acquisitions can be made that will help the company grow their verticals, becoming less of a play on smart homes, and more of a play on the smart cities of tomorrow.