SoundHound AI: There’s a problem with this growth story (NASDAQ:SOUN)

The company and its financial situation

As Seeking Alpha explains: SoundHound AI Inc. (Nasdaq:SounHoundify is a California-based company valued at $1.67 billion that develops voice AI solutions for a variety of industries, including automotive, television, IoT and customer service. The company’s products include the Houndify Platform, which provides tools for building voice AI. SoundHound Chat AI integrates voice assistants, real-time data such as weather and sports. It also offers SoundHound Smart Answering for custom AI-powered voice assistants, CaiNET and CaiLAN software for improved query processing, and solutions such as dynamic interactions, smart ordering, and employee assist. Here’s how the company has developed from his founding in 2005 to today (graph taken below) Previous IR Presentation):

More than 10 years have passed since our founding in 2005. The first product was created. It took another 5-6 years for SOUN to make its first real sales and acquire its first few customers, mainly in the automotive sector. Now that the entire market has realized the importance of Voice AI in manufacturing, the company’s sales are growing exponentially as it expands its deployment to other end markets.

In other words, either the product the company is developing is so sophisticated and unique that it takes a very long time to develop, or the management is just incompetent and SOUN is being saved because of the AI. Either it’s just hype. Or maybe both. Let’s evaluate it.

But first, it’s worth considering how efficiently the company has grown in recent years.

After confirmation Latest Q10 filing In the first quarter of fiscal 2024, the company saw a significant increase in revenue of 72% year-over-year. However, what was more striking was that while cost of sales more than doubled during the same period, R&D and SG&A expenses only minimally increased by 4.9% and 13.7% year-over-year, respectively. This disproportionate increase in COGS can be attributed to the “disease of scale.” As a company expands to new locations, the effort required to establish and optimize on-site operations increases, which tends to significantly increase COGS since these costs would normally fall under COGS. Perhaps SOUN will have less issues with this in the future, but currently the company is increasing costs more than revenue. As a result, the operating loss in the first quarter of fiscal 2024 was approximately $28.5 million, approximately $3.3 million worse than in 2023.

SOUN’s diluted earnings per share came in at negative $0.12, which is clearly not the development the market was hoping for. GAAP Negative Earnings Surprise:

Due to the increase in SOUN’s net loss, operating cash flow also decreased significantly. This was down about $22 million, nearly double the company’s revenue in the first quarter. At the same time, SOUN’s cash reserves increased significantly ($226 million from $46.5 million in Q1 FY23), as the CEO noted during the press conference. Final earnings reportThat’s true, but the increase is primarily due to proceeds from the issuance of Class A common stock, and we don’t see anything special in terms of the quality of the operations. By quality, I mean at least a hint that SOUN is trying to manage costs and working capital while growing sales, but that remains to be seen. Yes, this is definitely very significant – raising about two years’ worth of additional cash. At current operating costs, giving the company some breathing room and room to further scale. However, unless there are fundamental changes, I expect SOUN to need to raise additional capital in the market to sustain growth and dilute current investors. We haven’t talked about cost optimization yet. This is a risk that cannot be ignored.

That’s not to ignore the fact that SoundHound’s addressable market is growing rapidly. According to Speechify, this market is estimated to reach a value of up to $26.79 billion at a CAGR of 17.2% during the forecast period 2023-2028. The total value of the AI ​​industry, including the voice market, is predicted to exceed $190 billion by 2025. Obviously, management is targeting the second of his two numbers (i.e. $190 billion), but adjusting it to the region where the company is located. the current.

Our Pillar 2 target market size is over $100 billion, and we estimate that we can provide solutions to more than 1 million restaurants and approximately 30 million businesses in North America alone. We already offer dozens of languages ​​to our Pillar 1 customers, and we have plans for international expansion in Pillar 2.

What pillars is management talking about? The company categorizes its products and services into two pillars. Pillar 1 is about “automotive services” and includes driver assistance, smart TVs, home devices, etc. Pillar 2 focuses on “customer service” and primarily targets restaurants, food delivery clients, call centers, and similar end markets.

Returning to the question at the beginning,However Sound Hound Although the company has a very long history and offers a complex product, it has struggled to make a profit for many years. Until the recent uproar over AI, the company was not able to effectively sell its products. In my opinion, the niche market in which the company operates is very large, and SoundHound has potential because it is a pioneer in this market. SOUN seems to have made great progress recently, and now that its products and services are monetized, I think it can aggressively grow sales in the coming years. This is good news and gives SoundHound a competitive advantage over younger peers who may not have as much experience or patents (according to SOUN’s investor presentation, the company has over 270 patents, of which over 155 are granted and over 115 are pending). SoundHound’s business structure and division by service offering type seem to me well-poised to adapt to changing market needs. On the other hand, I am concerned that SoundHound was not able to sell its products and services before the uproar over AI. This raises a question that I cannot answer: How consistent will the company’s offerings be for future customers? Will they be able to maintain their customer base as competition in the voice AI niche heats up? Only time will tell, but these questions definitely pose some risk for investors. What confuses me even more is the fact that Amazon (Amazon), Google (Google), Apple (AAPL), who already have a voice assistant. This would mean a lot of competition for SoundHound, especially if these tech giants decide to make more aggressive attempts to monetize their innovations on this front (outside their ecosystem).

While SoundHound has been successful in attracting new customers in recent months (at considerable expense), the main issue investors may face is the size of SOUN’s market and current valuation. I think there is.

Soundhound’s evaluation is a problem.

Let’s assume that management estimates the potential size of the addressable market to be $100 billion within a few years. However, the company is already worth about 1.67% of that market, even though his TTM sales have only earned him $50.8 million so far. In my opinion, it’s a drop in the ocean. But that’s not the problem I see today.

What I’m confused about is the valuation. On a TTM basis, the price-to-sales ratio is one of the few indicators that can be analyzed today. This is 32.9 times (market capitalization to TTM sales), which is a very high number since we are talking about sales and not profits.However, on a FWD basis, approximately 23.6 times in 2024 It will increase 16 times in 2025. today’s consensus correct.

The market expects SOUN’s revenue to grow 53.74% year-over-year in FY2024 and 46.55% year-over-year in FY2025. At the same time, the consensus expects SOUN’s earnings per share to improve from -$0.31 in FY2024 to -$0.21 in FY2025 (a 47% improvement). I believe SOUN’s revenue momentum is not enough to break even. The company continues to make significant losses, and I believe that sooner or later it will have to dilute shareholders or increase borrowings, which will put further pressure on revenue and profits and delay breakeven.

Also, SOUN is a series of EPS Revision Following the Q1 FY24 report, the size of FY2025 forecast EPS has fallen by over 16% in the past three months, which only reinforces that the risks I outlined above are closer to reality than many optimistic buyers think.

These corrections certainly explain the share price movement over the past few weeks, with the stock down 43%.

Given the volatility, I wouldn’t be surprised if there were new buying attempts on this dip, but a next step up would not make the company any more attractive; if anything, it would exacerbate the risks I wrote about in today’s article.

Summary Conclusion

When you consider everything I wrote above together a pretty interesting picture emerges.

beginningAlthough the company is experiencing rapid growth, the growth in cost of goods sold has far exceeded the growth rate in sales, which is not a good sign of quality. In my opinion, there is a looming risk of dilution in the future, and very few people are paying attention to it right now.

Secondlythe company’s valuation appears to be quite high. The key here is not that the company is trading at 32x TTM sales, but that this multiple is expected to fall to just 16x by the end of fiscal year 2025. By comparison, even during the 2020-2021 tech boom, the median valuation multiple in M&A deals only increased slightly, from 5.8x to 6.4x. According to Aventis AdvisorIn my opinion, SOUN is truly overvalued, even considering its implied sales growth forecast, as the multiple contraction factored into the price today is too conservative. In the valuation section above, we did not mention any specific numbers that would indicate a fair valuation for SoundHound. For growth stocks, that’s pretty hard to do. However, based on basic logic and 2020-2021 M&A transaction history, the company’s P/S will not fall to 16x as some Wall Street analysts predict. In fact, I think it should go down to about 10 times. That in itself is a premium for superior growth rates. In this case, based on my calculations, we are likely to see an overestimation of at least 37.5%.

The thirdThe recent string of downward EPS revisions has raised many questions about how realistic an early breakeven point is. Seeking Alpha’s Quant Grades explains these three points as succinctly and colorfully as possible.

So why do I rate SOUN as “Hold”?

My anxiety comes from chart analysis. As mentioned above, the stock is down about 43% from its local highs, making it a favorable situation for those looking to buy on the dip. SoundHound stock is currently trading confidently above his 100-day moving average. Just recently, the price broke through a strong resistance level and settled above it, indicating the potential for further growth in the short term. Of course, this upward momentum, driven by the market’s fear of missing out on profits, will only make his SoundHound investment more expensive and volatile in the long run. But either way, this is a risk for short sellers, so I maintain a “hold” rating on this stock today.

thank you for reading!