[Research] Software, Analytics, and Services in Commercial Real Estate
Argus within Altus
Not held.
Overview:
Ongoing High ROIIC opportunities,
Medium-term margin inflection driven by the tapering off of cloud transition costs,
Misunderstood and supportive industry (CRE) dynamic leading to continued strong volume growth,
Value-based pricing transition,
Somewhat modest relative valuation driven by recent market dislocations and on-going business transition.
I think I’m yet to write about a company that hasn’t had an idiosyncratic founding narrative. This write-up, gladly, shall be no different.
While many of the companies I have written about in that past have revolved around residential real estate (the value nexus being in and around mortgages and transactions), this time I’ll be venturing into commercial real estate (CRE). The two worlds are farther apart than one might think.
If I were to say something off the bat it would be that the scale of assets we’re talking about here and the institutional, or professional, nature of the ‘investors’ (and we’re talking about legitimate investors here) takes a lot of the hot-housed dynamics that revolve around residential ownership, management, and transactions out of the equation. To be sure CRE has had a very challenging couple of years. Having said that assets aren’t always prone to the wild valuation swings and overheated transaction markets we see elsewhere.
As I hail from the property-mad shores of Australia, naturally one of my oldest friends is a CRE valuer (read appraiser depending on your locale). For almost a decade now I have been regaled with the tales of upset petrol station owners, eccentric no-named octogenarians sitting on 9 figures worth of cold storage facilities, and property developers offering cash under the table for favourable valuations.
The role of the valuer is central to the entire CRE complex. These assets need to have constantly assessed values for a wide variety of reasons - some market demanded and some imposed by the authorities. Insurance and tax reasons are foremost. Likewise, lending institutions rely on regular valuations to judge the credit worthiness of borrowers and of their own lending book. Third-party valuers play an important intermediary role between a wide variety of market constituents, and valuation firms (those who are both standalone, and in-house at large professional service firms) are pretty good businesses. They enjoy recurring revenues (once an asset is created it will need ongoing revaluation for the life of the asset), valuation methodologies tend towards standardisation (risk aversion), and they follow a typical professional services firm ‘pyramid’-type structure.
While business like CoStar have built up wonderful proprietary data assets and software businesses by aggregating listing information (sometimes by hand and foot!), there have been some crown jewel assets built up on the valuation and analytics side of things in CRE.
Altus Group was founded via the 2005 merger of three real estate consulting firms. The company has gone through a number of corporate identities on the Toronto Stock Exchange (where it is currently listed) - its original conception being a listed income fund. In 2011, certain tax rulings on distributions compelled Altus to list as a regular corporation. The earlier years of the company saw it focus on its original business in property tax consulting which it has only recently divested. This business operated not only in North America but also in the United Kingdom. Importantly, in 2011 Altus acquired Argus Software. This was a sizable departure from their early years and saw them expand into a categorically different market.
The Argus acquisition was a great piece of corporate theatre. From 2005 to 2011 Altus was led by Gary Yeoman, who in turn had been the chief executive of one of the three founding services firms. The acquisition of Argus happened nearly concurrently with Altus’s transition from income fund to corporation. The acquisition was funded with a large slug of debt that ballooned the company’s net debt-to-EBITDA profile out to fives time. Naturally the dividend had to be cut to fund borrowings. The existing shareholder base, who were largely motivated by yield, now found themselves holding the shares of a heavily levered vanilla corporation with little prospect of imminent capital returns. The shares traded down over 80% from top to bottom tick in 2011 and Yeoman was unceremoniously turfed out of the company that he had helped found.
Yeoman was ultimately replaced with former SAP (an association we will come back to) Vice President and head of North American sales Robert Courteau. The appointment signalled Altus’s intention to focus on the data and software business that had cost Yeoman the top job. Courteau himself had something of an acrimonious exit from SAP in the early 2010’s when a poor quarterly earnings result saw him fall out with the then CEO. After taking a short sabbatical he took up the reigns at Altus.
In 2012 Courteau laid out a comprehensive plan to shareholders that illustrated a business transition from services firm to a software-first company. Over the next five years he did exactly that. This culminated in 2017 when Argus sun-setted Argus DCF (the long-time flagship software product), and rolled out the beginnings of Argus’s transition to the newer Entreprise product, and later to the cloud more generally (specifically AOD). In a similar to fashion to about a bajillion other publicly traded software companies who have transitioned to cloud, Altus saw near term weakness in its sales figures as upfront licence scaled back and longer term, although more protracted, recurring revenue increased.
What Altus now terms Argus Enterprise (its one-stop platform for all things CRE valuation everywhere) partially started life as a discounted cashflow valuation tool (referred to as Argus DCF above) for the North American market. This tool was founded back in 1985 under the auspices of Realm Business Solutions. Software like DCF offered property valuers and investors a much more efficient solution than Microsoft Excel and its forebears. Putting aside the fact that valuation methodologies can differ even across different geographies within a country as big as the United States, Excel historically has been ill-suited to a whole range of use cases, and can become incredibly cumbersome when applied at what a fund or an investor would refer to as the portfolio level. To replicate what products like Argus can do, one might need to manually construct Excel spreadsheets with up 100,000 lines of inputs. I’ve never done this myself (god forbid I ever open Excel!) but I’m reliably told that monstrosities like this are incredibly expensive to create and maintain.
The Argus-come-Excel debate, which amazingly still rages today(!), basically gets settled at the point of complexity. Modelling the valuation, timing of cashflows, and making projections about the future of a single family apartment is not particularly difficult. On the other hand modelling out a collection of retail and grocery assets is a completely different story. This is where Argus originally shone as DCF, and where it currently shines a little less as Enterprise, according to multiple reddit forums at least.
Argus is commonly referred to as a standard in North America - and sometimes as ‘little less of a standard’ elsewhere. What underlies this position is two things. Firstly, and unsurprisingly, is multi-party co-ordination. As mentioned before, the valuation process, and the users of its outputs are numerous. Transactions are illustrative. To any property transaction there is a vendor, buyer, and brokers. Valuers may sit within or outside of the parties. Likewise, various financial institutions (lenders, insurance) comprise another group. While brokers are more interested in narratives than numbers, a range of information will be shared between vendor and buyer during the diligence process. Naturally, as the owner becomes more sophisticated so too does the processes that will be in place. Importantly, valuation information, and its inputs, can be transferred between parties by a specific Argus file. The form of aggregation that’s present in the North American market is evidenced by 1). the fact that there are no close commercial competitors1 (Argus enjoys 73% market share among Top 200 CRE investment managers), and 2). while customers may complain about the functionality the only legitimate alternative is apparently Excel. Remember for a second that the latter option isn’t a for-purpose tool, and comes with a M365 subscription.
Certainly the presence of Excel as a widely accessibly tool has definitely helped Argus in the sense that it makes moot the possibility of a competitor gaining any kind of share by offering a better and cheaper product. Competitors simply find it hard to get revenue as their real competitor is essentially free.
Secondly, use of the platform requires users make their data available to Argus. This creates something of a feedback loop element where proprietary asset level information can be used holistically to provide better and better analytics to other customers (and creates a valuable proprietary data set). Certainly as users have larger and larger warehouses of information Argus’s solution becomes ever more integrated in their workflows, and nearly impossible to remove.
Outside of North America things are decidedly different. As valuation methodologies tend toward different foci, the desirability for custom built solutions becomes more acute. In the 2010’s, Courtaue’s strategy was to simply buy up regional players. At about the same time that DCF was end-of-life’d a number of these regional acquisitions were also shut down as a way to brute force their users bases into Enterprise. This dynamic was well illustrated in the ill-fated story of Circle Software, once based in Mill Hill in the United Kingdom. Circle was acquired by Realm (Argus) in 2007 as it had become the industry standard tool for Red Book traditional valuation in the UK. The nuances of the prevailing valuation regime in the UK contrast starkly with the traditional American method and the successor products to Circle were woefully inadequate. Anecdotally, only recently has Argus Enterprise recaptured a majority of the functionality once available in the specialised local products.
In other farther afield markets Argus’s products do not occupy the same dominant position that they do in North America. Vendors and buyers often share information via more traditional methods. Enterprise offers the spectre of eventually being the end-all-be-all of global valuation, but that eventually isn’t certain, and likely no time soon.
The entire DCF/Enterprise/ValueCap saga only relates to Altus’s software offering which itself is only a part of what they refer to as Analytics. However, alongside this core software franchise, and within Analytics, is valuation management services (VMS). VMS are software enabled third-party recurring, appraisals for CRE investment portfolios. This is another interesting business within Argus that leverages the very same standardisation dynamic I have already discussed above.
In the past it has not been uncommon for large institutional CRE investors to find themselves in an asymmetric relationship with their third-party valuers. For instance, a large investor (Blackstone for example), like all investors, will find themselves in a very tricky situation if they have volatile valuations of their portfolio at any moment in time. They are managing trillions of dollars of investor capital themselves and having periodic unfavourable revaluations is in no ones interest. Of course, if they are using a third-party valuation service (like CBRE) they know that they can leverage the size of their business to their advantage. Large asset managers can take their business elsewhere and most valuation/appraisal firms knows this. Unfortunately regulators and investors know this too. Argus essentially plays the roll of an impartial middleman here, certifying valuations using supplied data from clients, but also from their own proprietary set of 53+ million assets valued on the platform.
This is something of a continuation of Altus’s traditional appraisal business but it would be impossible without Argus. The key value proposition here is not significantly different from what the credit ratings agencies do on the corporate debt side. The applicable market, however, is for funds which require an impartial third party adjudicator that the other other parties can trust. This is an unusually good business that boast 30%+ EBITDA margins and actually benefits from market volatility. While large funds typically value their portfolios quarterly, dislocations in the market - like what has been experienced in CRE post-Covid - can be catalysts for additional valuation activity. Having said that the environment we find ourselves in is not particularly favourable for valuations.
The corollary of this business is Argus’s opportunity in supplying benchmark standards to CRE funds generally. The opportunity here is a little more nascent, and certainly less well disclosed, but by many accounts this could well be a business worth several billion dollars with the excellent economics to boot!
Since 2019 there have been a number of developments at Argus specifically, and Altus more generally, which have been obscuring the larger transformation that management began over a decade ago. In 2020, Corteau stepped down as CEO, but remained on the board. He was succeeded at first by Mike Gordon who left two years later to become the CEO of a private healthcare software company. Gordon was succeeded in turn by Jim Hannon, who auspiciously spent four years as FICO’s VP of Business Operations in the early years of current CEO Will Lansings tenure. This was followed up with several years as CCO of Callcredit Group which was acquired by Transunion before he joined Altus in 2020.
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