The Curious Settlement of Yardi v. RealPage
On July 2nd RealPage (“RP”) and Yardi announced the settlement of their litigation.
First things first, my tail risk thesis has been rendered null and void by the settlement. I argued, in my last post, that the litigation could result in large monetary damages, which RealPage had not reserved for and could not afford to pay without taking a large hit to its future earnings. This outcome did not happen and therefore part of my valuation thesis was wrong.
According to RP’s 8-K, they will only take, at most, a $12 million hit to their second quarter earnings. This will likely mean that RP will report a loss in the second quarter on a GAAP basis. The $12 million will be added back to adjusted EBITDA and since the market generally seems to value RP on an adjusted EBITDA, the effect of the litigation costs is negligible to RP.
RealPage and Yardi each put out their own respective statements on the settlement - Realpage: http://investor.realpage.com/releasedetail.cfm?ReleaseID=688350 and Yardi: http://www.yardi.com/US/legal.aspx.
Without a large monetary damages, analyzing the settlement and its effect on RealPage becomes more nuanced.
The key language of the settlement can be found in the last two sentences of RP’s press release (this language is the focus of Yardi’s much shorter statement):
RealPage will continue providing Voyager hosting to current clients for five more years. RealPage also has agreed to stop offering hosting services for Yardi software to new customers and to stop providing support or implementation services for Yardi software.
And here is Yardi’s entire statement:
Yardi Systems, Inc. has announced a comprehensive settlement to the litigation that has been pending between Yardi and RealPage, Inc. since January 2011. As part of the settlement, RealPage will immediately stop offering to host Yardi software for new customers. RealPage will also immediately discontinue offering implementation services and all application support and training services for Yardi software. RealPage may continue to host Yardi software in the RealPage Cloud for existing RealPage Cloud customers only, for up to five years. In addition, Yardi and RealPage have granted to one another perpetual licenses to their standard interfaces, providing interoperability and choice to common clients.
So in essence, the settlement prohibits RP from hosting Yardi’s software on its servers for new customers. And for current customers it can continue to host Yardi’s software for five years. RP also immediately has to stop servicing and providing support for Yardi’s software for current and future customers.
No big deal right? I spoke to the investor relations department at RP and they said as much. The cloud is only 3% of their current revenue, so the settlement has no material impact on them.
The problem with this logic is that it assumes the real estate management software industry is static and that the RP Cloud infrastructure, along with the ability sell additional software as a service (SaaS) into that infrastructure is not important to the future of RP.
I have recently re-read all RP’s earnings calls since the IPO in 2010. And what is noticeable is RP’s management tone pre-Yardi litigation and post litigation with respect to the cloud infrastructure.
In their first call in November 2010, RP’s management was eager to talk to sell-side analysts about the cloud and its importance in cross-selling software.
For example, here is a comment from RP’S CEO, Steve Winn, on RP’s first quarterly conference call after the IPO in November 2010:
it’s a catalyst for facilitating the sale of all of our SaaS products because we’re — data is hosted and our data center, and the integration tends to be as good as it could get when you do that. So we believe that infrastructure as a service is very complementary to our SaaS offerings, and candidly, that’s the primary reason why we’re in that business.
But as the litigation was filed and progressed with Yardi, RP’s tone about the cloud changed fairly dramatically. They began to deemphasize it.
RP claimed it was because Yardi’s litigation unfairly interfered with their business. Yardi would say in response that RP’s cloud customer wins in November 2010 was the result of RP’s interfering with their business by stealing propriety information.
Either way, it is clear based on the settlement, that RP’s cloud infrastructure might become permanently impaired.
I imagine RP’s management will continue to say this is no big deal. But the question for investors is not what RP’s management tries to tell sell-side analysts, but what the reality is and where the industry is actually going.
To help understand the potential effect of the settlement on RP, I included below every reference to the Cloud and SaaS from RP’s quarterly conference calls since the IPO.
As you read through the transcripts, see if you notice the shift.
From November 3, 2010 Conference Call:
Our top five multi-family deals for the quarter included broad-based adoption of product families with particular emphasis on the RealPage cloud, our infrastructure-as-a-service offering, and YieldStar, our asset optimization system. We recently closed four cloud service deals, including Riverstone Residential, Pinnacle, and Greystar, which are the three largest apartment managers in the United States per the latest National Multi Housing Council report.
Large customers have responded to the RealPage cloud because it enables owners and managers to outsource portions of their IT operations and divert internal IT resources to more strategic business process improvement initiatives within their companies.
ROB BREZA, ANALYST, RBC CAPITAL MARKETS: Nice quarter. Steve, I was wondering if you could talk a little bit more about the cloud wins that you had. You talked about four of the big deals. Is it more of a focus from the sales effort? Really just wanted to get more clarification in how you see that traction going forward may be over the next 12 months.
STEVE WINN: Clearly, the concept of infrastructure-as-a-service is now becoming understood in the industry as it has in many other industries, and we’re typically excited that the three largest management companies in the US saw the value and literally all moved to the cloud in the same quarter.
This line of business is still only 3% of revenue, so it’s not big, but we do think there’s a significant value proposition to the industry to adopt cloud infrastructure versus trying to finance and manage these complex systems themselves.
TOM ERNST, ANALYST, DEUTSCHE BANK: I have two for you today. Following up on the questions on the infrastructure-as-a-service, my understanding is a couple of your early deals were at some of the larger customers in your base. These four newer deals you have; are they also with larger customers? And then, what is this doing in terms of your ability to sell the broader suite into the customer when you host the infrastructure as a service for them?
STEVE WINN: Well, to answer the last question, I think it makes — it’s a catalyst for facilitating the sale of all of our SaaS products because we’re — data is hosted and our data center, and the integration tends to be as good as it could get when you do that. So we believe that infrastructure as a service is very complementary to our SaaS offerings, and candidly, that’s the primary reason why we’re in that business.
These bigger wins we’ve been working on for a long time and they just finally came together in this quarter. It could have happened sooner because we’ve been working on them for a year. Maybe I didn’t understand the question —
TIM BARKER: Yes, Tom, the four we talked about were at the four large ones.
TOM ERNST: Right, that’s what I thought, okay.
And I recognize you’ve only had a couple of these deals prior to these new deals in infrastructure-as-a-service, but what has been the track record of continuing to upsell into that base once you’ve got them hosted in your data center?
STEVE WINN: It’s been — it’s a little early to tell for sure, because we have a substantial amount of business already from Riverstone, Pinnacle, and Greystar. But, specifically, in the case of Riverstone, they have expanded the use of other SaaS offerings that we have co-terminus with the move to the cloud, so there is evidence here that there is a linkage.
From May 5, 2011 Conference Call:
Finally, revenue from the RealPage cloud offering grew significantly over last year. Notwithstanding year over year growth in Q1, we believe the success of our cloud offering and related consulting services has been damaged by uncertainties surrounding the lawsuit that is now pending between RealPage and Yardi Systems.
As you know we responded to Yardi’s complaint with an answer, affirmative defenses and counterclaim. That counterclaim explains why we are seeking judicial relief from Yardi’s interference with our business relationships and clients.
Our cloud revenue and consulting services are immaterial to our overall business. But the cloud does deliver a substantial value proposition to our customers which we highlighted in our April 25 press release.
From August 4, 2011 Conference Call:
STEVE WINN: As a SaaS provider, one of the benefits that RealPage brings to the table is very low implementation and training costs. Our implementation and training revenue is only 5% of total revenue. If you contrast that with a typical software or ASP, they’ll have 30%, 40%, 50% of their revenue generated from professional services. So we are highly motivated and highly successful at reducing the overall cost of implementation and training, as evidenced by the fact that we’re generating such a small amount of revenue from that activity.
Now the cost to implement is very dependent upon the product centers. Clearly, when you replace your back office accounting and property management system, that is going to take more consulting than, say, screening or renters insurance, or even the contact center is very easily brought up.
So there’s no simple answer to the question. It’s a function of what product we’re talking about. But SaaS is the advantage here because we can bring the systems up very cost-effectively.
STEVE WINN: The competitive landscape is always tough. There’s some really good competitors out there that we compete against in every product family. Yardi, we primarily see in the property management area, although they have expanded their presence into screening and utility billing and a few other areas. But they’re not — they haven’t reached a critical mass in those other areas where there are serious competitors. But those other areas do have very serious competitors.
I guess the cloud, which represents a very small percentage of our revenue today, I would say is being impacted from a competitive standpoint, primarily due to Yardi’s interference. They do not want RealPage to host or support their application, and they are attempting every way possible, including illegal ways, in our opinion, to block the sale of the cloud. And I think this is most damaging, candidly, to the industry because the industry desperately needs the performance and cost advantages that the cloud brings to them. But that’s really the only area where I’d say things have really changed, is in the cloud. And again, stress this is a very minor part of our overall business today.
From November 1, 2011 Conference Call:
RICHARD BALDRY: Yes. And do you leave them as really product specialists in the line they’re brought in with, or do they (multiple speakers)? Right.
STEVE WINN: There’s not a hard and fast rule here, but I would say the majority do stay as specialty reps for the product family, not necessarily the product. So, if you look at each product family like LeasingDesk and LeaseStar, and we would have a specialty rep that is qualified to sell all of the individual product centers that make up a particular product center or family. The largest number of reps clearly are the general territory reps that support all products.
With respect to competition, I — we generally don’t like them, but — because they’re all tough in every market that we compete in, there’s some very good high quality companies that we compete against. So, I haven’t seen a change in the competitive landscape really. They’re as fierce and they’re hard to compete against today as they were three months ago. I think we have some significant differentiation between ourselves and all of the competition that we compete against. Our primary differentiator, of course, is our SaaS platform, and our total comprehensive integrated solution, which none of the competition has really been able to [piece] together and offer.
So that will be the way we differentiate against the overall market. But having said that, it is paramount that we being best of breed within each product family, we can’t rely on the overall integration to win a deal, if we’re not at least at parity and ideally better in terms of the functionality of each product family that we offer.
I don’t know that the Yardi lawsuit is going to have any impact on competition other than the RealPage Cloud, which we have discussed in previous earnings calls. Yardi has been successful in dramatically slowing down the growth of that particular opportunity for us. So, until this matter is resolved, I’m not anticipating that the RealPage Cloud is going to be a big contributor of growth to RealPage.
From May 3rd, 2012 Conference Call:
JEFF HOUSTON: Okay. Then separately, turning to competition, are you seeing more of Yardi now that they have introduced a SaaS product? And have the win rates changed at all when you do face off with Yardi?
STEVE WINN: Well, Yardi recently announced a SaaS platform, which we’re delighted they finally adopted the model that we’ve said is the correct way to do business. It’s too early, I think, at this point to know what impact that’s going to have on the market. And remember that Yardi and RealPage compete in this area where they released their Voyager SaaS product primarily in the ERP product family, which is a reasonably small percentage of our overall revenue now.