It Is a Digital World, but Where Are the Buildings?
Of Digital Twins and Analog Maps
Welcome to a brand new year! I hope 2023 treated you well. As we embark on 2024 together, I wanted to give a warm greeting to all my loyal newsletter subscribers. We are approaching one year together. Whether you've been subscribed throughout the whole period or are brand new, thanks for reading!
If you haven't subscribed yet and came here by chance or were referred by someone, Student of Value is a mostly about investment ideas from across the globe. Last year for example, it featured 12 companies coming from 8 countries: the UK, Greece, Japan, Norway, Kazakhstan, Bulgaria, France, and of course, the US. You will also find some fun reviews and thoughtful reflections here. I like to keep the content varied, maximizing the chance that we all learn something new.
Now let's dive in...
Following the last post about Zillow is this complementary service that has become a standard in real estate listings. A company that develops 3D cameras and software to create digital twins of physical spaces.
Leading the digitization and datafication of the built world.
Matterport is best known for its 360-degree 3D camera technology that quickly captures spaces and generates photo-realistic 3D models that users can digitally walk through and measure. It's like creating a virtual replica of a space. Matterport claims 11.1 million spaces under management in its latest 10-Q.
These digital twins provide immersive and interactive experiences that can be used for a variety of purposes, such as virtual tours, property listings, training simulations, and facility management. I find it surprising that buildings remained so solidly out of the digital world as everything else digitized. True, computer-aided design is nothing new, but what about after the design phase? Why don't we have an easy way to carry our buildings in our computers and phones as we do with most of our other information?
Certainly, capturing a 3D image is inherently much harder and computationally intensive than 2D. Until recently, it wasn't easy to capture spaces in 3D. We've had panoramic photos for roughly 15 years, and they sucked. Only lately, with the advancement of cameras and the addition of LIDAR to smartphones, capturing 3D spaces became available to the average person. Of course, this is not the high-quality imaging that is possible with professional equipment, but it is a working alternative that will almost certainly keep getting better. At some point we will be able to do all the measuring, planning, and design for our renovations much more easily and accurately off of our property's digital twin.
Matterport operates under a freemium business model, offering a basic service for free and charging a premium subscription fee for access to advanced features and functionalities. The pricing for Matterport's services is structured to encourage early adoption and grow its user base, with customers paying between $10 to $300 depending on the number of users and the tools they need.
The majority of our subscription services are billed either monthly or annually in advance and are typically non-refundable and noncancellable.
Its technology is used in a variety of industries including real estate, travel and hospitality, facilities management, construction, insurance, government, and retail. Some of its biggest customers include Redfin, Airbnb, Cushman & Wakefield, and CBRE Group.
The largest vertical by far is real estate. Agents and brokers use it to create virtual tours of homes and properties. These virtual tours make it easy to reach a wider audience of potential buyers and provide them with a more immersive experience.
Virtual tours became the default viewing mode during the pandemic. I myself visited several cities and interesting sites virtually during that period. In the spirit of the season, you can find a tour of the North Pole City on Matterport's Discover site. It is almost as smooth as taking a walk in a 3D video game. And what is more, they have a huge library - from classic car showrooms and AirBnB's most popular treehouse to the Oxford Museum of Natural History and Abu Simbel Temple. These are also available to view in VR and it is definitely something that I would love to try one day. Meta Quest 2 is the recommended headset.
What Zillow did for property valuations, Matterport is doing for digitalization of places. It is democratizing access to 3D capture and visualization. Taking advantage of the the easily accessible and affordable technology (mobile phones) and providing its user-friendly software, Matterport makes it possible for anyone to create digital twins.
The real estate sector aside, Matterport scored two big wins - one in the facility management vertical and one in construction management. In January 2023, John Deere selected Matterport to build a virtual Operations Center for the remote management of over 60 manufacturing facilities across 4 continents. In September, Matterport announced that Procore, a leading provider of construction management software, could:
use features directly within Matterport’s photorealistic 3D digital twins, creating a visual system-of-record for site conditions, centralizing record-keeping and enabling better progress tracking, quality control, and more efficient closeout processes.
The company generates revenues from:
selling subscriptions to their platform
licensing data to third parties
selling professional capture devices
providing services to customer
However, Matterport lacks a true moat beyond early leadership. Its technology can be copied and, indeed, there are various other companies offering digital twins. Zillow has its own solution, tailored to its real estate listing niche. Zillow 3D Home is completely free, and it is integrated into the Zillow listing, boosting its ranking and viewership. AutoDesk also has Construction Cloud, tailored to the AutoCAD crowd. However, Matterport does have some competitive advantages:
Low-friction adoption - Anyone can use the Matterport app on their phone to create a digital twin of their place.
High-fidelity, high-accuracy digital twins - Specialized capture devices for the demanding professional.
Integrated system approach - Matterport offers the hardware (capture device), the software (app and Cortex AI), and the platform (Matterport cloud).
Huge content library - 30 billion square feet of space scanned provides valuable data that training computer vision models. This library helps to develop AI algorithms over time. This feeds Matterport’s Cortex AI and allows it to continuously improve.
Brand recognition - As a first mover, the Matterport brand is almost synonymous with immersive 3D walkthroughs in industries like real estate.
Vertical strategy - Focus on specific high-value industries provides leverage versus generalized competitors. Custom solutions tailored to verticals protect market share.
Integrations - Matterport integrates with Autodesk, which plugs in directly into designers and architects workflow, allowing project stakeholders to include information about behavior, performance, material types, and costs within the model.
Global presence - Many of the competing offerings are local and lack the scale to compete with Matterport.
Matterport's offering appears to be the most complete one. In summary, Matterport pioneered impressive 3D spatial data capture tech and is considered the gold standard for 3D tours, but still needs to prove the scale and sustainability of its business model over the long-term.
Cortex has been designed to scale with the rapid global adoption of Matterport digital twins, and deliver the most cost-effective solution on the market today. No other company offers a fully automated solution that scales so effortlessly in terms of both square footage, and time and cost to produce.
The key metrics that Matterport tracks are:
Spaces under management (SUM)
Total subscribers (Subs)
Net dollar expansion rate (NDER)
Obviously, the bottom two rows in this table are concerning. Growth of paid subs has decelerated significantly in the first 9 months of 2023 and the expansion services into existing cohorts has been a meagre 6% over the past 2 years. I am much more concerned about the latter than the former. Given the overall cost-cutting theme which dominated 2023, I am not surprised by the decrease in paid subs. Moreover, the real estate sector has been frozen for the past year.
However, slow pace of subscription revenue growth from existing customers for such an extended period is surely something that calls for attention. Definitely, 6% expansion is better than shrinking revenue, but Matterport needs to do better than this for it to be cash-flow positive and to continue as a going concern. Management blames it on the slow residential real estate market:
On a combined basis, growth in enterprise customers remains strong, but smaller customers, particularly those exposed to the U.S. residential real estate market, continue to exercise caution on growing their spending as the macro environment has further influenced this cohort during the three months ended September 30, 2023.
Matterport became a public company on July 22, 2021 in a SPAC deal with Gores Holding VI, raising $640M gross from the offering. Today, it is approaching a million subscribers across almost every country imaginable.
Revenues come from:
Subscriptions - $22.9M or 56% in Q3 2023
Services - $9.9M (24%)
Product - $7.8 (19%)
License - $28K
This mix is roughly unchanged from 2022. The geographical revenue split is 66% US and 34% international.
The gross profit margin was 50% in Q3 and has averaged 45%. In absolute terms, it roughly covers the R&D spend, leaving SG&A uncovered. Coincidentally, SG&A expenses are higher than the company's total revenue. That's a big hole to scale out of. Last July, management initiated a restructuring consisting of 30% reduction in force and ceasing use of certain leased office spaces. The restructuring is expected to be complete by the end of Q4.
Matterport has made two small acquisitions in 2023 that complement its services. VHT Studios, a US real estate marketing company that offers brokerages and gents digital solutions to promote and sell properties was acquired for $22.7M in cash in July 2022 with the aim of increasing adoption of Matterport's digital twin technology and expanding further into the residential real estate industry.
Earlier, in January 2022, the company acquired Enview, which develops AI algos to identify natural and man-made features in geospacial data, for $64.3M in cash and stock.
Below is a chart of the company's performance since it became public.
As already mentioned, gross margin has been stable around 45%. SG&A is quite bloated at the stage. We are yet to see the effects of the ongoing restructuring on February 16, when Q4 results will be reported. SG&A and R&D consist mostly of SBC - the Schrödinger expense that is and is not an expense at the same time. For the purpose of calculating how much cash the company has before it runs out and needs to reduce itself to a digital twin of itself, we can ignore SBC as it is not a cash outlay and it can afford to keep paying management in monopoly money. The problem is that as the stock price decreases, management is compelled to increase shares granted to achieve a similar total value of the reward. This, in turn, increases the rate of dilution, which effectively deletes shareholder returns.
Herein lies the problem with Matterport. Shares outstanding are up 26% over the last 2 years.
Admittedly, that rate decreased to 6% in 2023, but this is still too high. A recent study by the TDM Foundation shows that companies with net dilution above 3% underperform the NASDAQ and largely deliver negative returns.
There is still a chance that Matterport brings dilution under control and returns to double-digit growth (subject to recovering real estate sector). The $430M cash in the bank and zero debt give it a good shot at putting the business on the right track.
It would be a stretch to try and value Matterport. There are too many assumptions to be made that I am not comfortable making. Either the fair value range would be too wide to be of any use or the level of confidence in the estimate would be too low.
I like the idea and the product that Matterport offers. It makes a lot of sense that buildings would be digitized and there would be more and more applications for digital twins. However, the financial and the busted SPAC background of the company are a big turn off, except maybe for the most adventurous among us.
While I was writing this, I remembered the story of another iconic map company. It used to offer very specialized maps to the insurance industry, but eventually risk pricing models evolved and the maps became obsolete. Not trying to push any parallels, other than the digitization of maps that started a long time ago, but I find the story fascinating and would like to revisit it here. Enjoy!
The Story of Sanborn Maps
In the late 1950s, Warren Buffett came across a small, little-known company called Sanborn Map that intrigued him. Sanborn Map produced extremely detailed maps of cities and towns, used primarily by insurance companies to assess fire insurance risks. By the time Buffett was building his position in the company, the main business was in decline, because insurance companies had switched to carding, where no maps were kept, and because industry consolidation meant fewer customers for Sanborn's maps. After-tax profits had gone down to $100K in 1958 from $500K in the late 1930.
However, the company had something else going for it. The mapping business was extremely capital-light. After being published, a map was updated by pasting updates over it annually. A new map would be published every 20-30 years when the original had become so cluttered that pasting over would be impossible. Buffett estimated that keeping the Omaha map (think multiple volumes weighting 50 pounds in total) revised cost around $100 per year. With profits declining, management had the foresight to plough the proceeds into a portfolio consisting of roughly even parts bonds and stocks. The cost basis was 2.5M.
Sanborn's stock was selling for $45 in 1958, when Buffett started acquiring it, while its investment portfolio was worth $65 per share, valuing the insurance maps business at negative $20. Keep in mind that although the business was in decline, it was still profitable - generating roughly $1 after-tax profit per share - and had a virtual monopoly in its niche industry.
Needless to say, Buffett felt quite positive about the odds on this bet, so much so that he had put 25% of his partnerships' assets into Sanborn Maps at the time of first mentioning "this new situation" in his partnership letter from 1958, not specifying the name of the company yet. In the 1959 letter, he revealed the name and the investment had grown to 35% of assets.
In effect, this company (Sanborn Map) is partially an investment trust owning some thirty or forty other securities of high quality. Our investment was made and is carried at a substantial discount from asset value based on market value of their securities and a conservative appraisal of the operating business.
The Buffett Partnerships ended up owning 23% of the shares outstanding and aligned with two other large holders. The group wanted to unlock value by separating the investment portfolio from the map business and liquidating it (the portfolio, not the business). They also saw an opportunity to significantly improve the business by going digital.
There appeared to be a real opportunity to multiply map profits through utilization of Sanborn's wealth of raw material in conjunction with electronic means of converting this data to the most usable form for the customer.
This plan didn't go through. Wikipedia tells us that:
Sanborn printed its last catalog in 1950, created its last new map in 1961, and issued its last update in 1977.
Nevertheless, Buffett generated 50% returns over 2 years for his partners as Sanborn's Board agreed to exchange tendered shares for portfolio securities at their fair value.
You can read the full story straight from Buffett's partnership letters diligently collated at csinvesting.org.
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