AppFolio: Moving Up Market in Property Management Software

You can listen to this Deep Dive here

“…we invested in the IPO, we purchased after the IPO from other investors. And pre IPO, there were other strategic investors and their mandates can change, they make an investment in year two, and in year seven, they have somebody else running their strategic investments and they decide they're willing to sell it and we--so all along this spectrum, from Series A to public companies, and then you look at it, and you say we know the company backwards and forwards, we know the management backwards and forwards, we know the opportunity backwards and forwards. Why would we harvest it and then recycle the money when we have an opportunity to continue to be big owners in an exceptional company?”

This quote was taken from the interview of Maurice Duca, who is arguably a good candidate to be on the Mount Rushmore of investing. The company he’s talking about is AppFolio. Mr. Duca alone owns almost one-fifth of the shares outstanding and ~40% of voting power at AppFolio.

Mark Leonard, CEO of Constellation Software (CSU), once asked investors for thoughts on AppFolio. CSU executives even said the following during 2023 AGM:

…What we do each quarter is we profile a venture-backed vertical market software company that has done well. And through that process, we can get a sense of how they penetrate markets, what the economics of what they're doing are, what underlying technologies they're using and the advantages they have versus their incumbents.

And I think we've done 8, 9 of those so far that we do want -- We're doing AppFolio, for instance, this quarter, which is stunningly attractive property management software company that penetrated a relatively mature market and did so in a very economic fashion. So we're not blind to technology or to new approaches and we try to learn from them.

While I rarely cover companies with <$10 Bn market cap, you can probably understand why I felt compelled to do a Deep Dive on AppFolio.

AppFolio was founded by Klaus Schauser and Jon Walker in 2006. They knew each other for years and started talking about launching web-based software for specific industries that they thought were underserved. They both had startup and tech background. Schauser used to be CTO of Expertcity (now “CitrixOnline”) during 1999-2006 and was visionary behind products such as GoToMyPC, GoToAssist and GoToMeeting. Walker was also CTO of couple of companies (Versora, and Miramar Systems) before founding AppFolio.

After brainstorming and speaking with customers from different industries, Schauser and Walker narrowed their focus to property management industry due to its relative laggard status in digital transformation and inefficiencies embedded in the traditional way of doing business. Since they both used to be CTOs, they decided to beef up their management by hiring a CEO in 2007: Brian Donahoo, who worked with Schauser at Expertcity and grew revenue to $240 mn. Donahoo took the company public in 2015 and eventually was replaced by Jason Randall who joined AppFolio back in 2008. Randall then grew the business from $144 mn in 2017 to $472 mn in 2022, a~27% CAGR over 5-year period. Then in early 2023, Shane Trigg became CEO who joined the company right after the pandemic started.

Although the name “AppFolio” carries the original ambition of the founders to build “a portfolio of business applications for various different vertical markets”, AppFolio basically only doubled down further into the first vertical market they found their product market fit: property management software. The founders are no longer around. Schauser used to be in the board, but left in 2017 although he still owns ~10% shares and ~23% voting power (as per 2023 proxy filings). Walker remained CTO until 2023 and then left to become CTO of Buildertrend, a company that builds software solutions for construction industry. He still owns ~2% of AppFolio shares.

As you can see, there has been quite a few management turnover since AppFolio’s founding. While that may seem less than ideal, the stock has been almost a 15-bagger since its IPO in 2015!

Here’s the outline for this Deep Dive:

Section 1 AppFolio Overview: I discussed a brief overview of the platform, revenue drivers, and overall economics of the business.

Section 2 Competitive Dynamics: I looked into some of AppFolio’s competitors, compared and contrasted with RealPage’s economics, as well as switching cost of moving away from incumbents’ (Yardi, RealPage etc.) software. As AppFolio navigates to up market, the key question is how difficult or easy it is to unseat the incumbents.

Section 3 Management, Capital Allocation, and Incentives: I briefly outlined capital allocation philosophy of AppFolio management and incentives of the management. I have also touched on the role AppFolio’s board play.

Section 4 Model Assumptions and Valuation: Model/implied expectations in the current stock price are analyzed here.

Section 5 Final Words: Concluding remarks on AppFolio, and disclosure/discussion of my overall portfolio.