SSTI - ShotSpotter - Not Taking A Shot Yet

2023-04-06 17:01:21 ET

Summary

• Shares of ShotSpotter, Inc. have seen continued growth since its IPO.
• The company has not been able to become really profitable yet.
• Concerns on the potential loss of Chicago, the biggest client, have triggered a big pullback.
• This pullback looks compelling, as it smells like an overreaction, but I fail to see long term appeal here with ShotSpotter, Inc.

In February 2020, just before the Covid-19 pandemic was holding the world in its grip, I last had a look at shares of ShotSpotter, Inc. ( SSTI ). I concluded that I was not aiming for it yet.

At the time, I provided an update after I had last covered the shares when the company went public in 2017. At the time, I concluded that it was a risky, yet potentially lucrative, IPO, which turned out to be the case in the years which followed.

As SSTI shares have seen a violent move lower in recent days, it is time to update a dated thesis here.

The Thesis

When the company went public, I was attracted to its solution, as the relative low-cost gunshot detection solution helps cities, enforcement officers and security staff to respond rapidly to shootings by literally listening to the sound of a gunshot from multiple angles. At the time, the company had customers in 89 cities, believing that there was a market which totaled about 1,500 cities, which were potentially interested in its services.

The company went public at $11 per share, giving the company a miniscule market valuation of $100 million, with that number even including a $15 million net cash position. This was attached to a business which generated $15 million in revenues in 2016, posting an operating loss of $5 million in the process. Given the potential and distinctive offering I was appealed to the shares, even as they were risky. Following a move higher I sold out at $30, as shares even hit a high of $60 in 2018.

2018 sales rose by an impressive 46% to $35 million as net losses narrowed to $2 million and change. Early in 2020 shares had fallen to the $20 mark, translating into a $200 million operating asset valuation. While the company saw 2019 sales grow to about $40 million, that fell way short of the original guidance, although the company guided for 2020 sales to levels as high as $50 million with some margin gains seen. This guidance caused shares to rise to $35 when I last covered the name in February 2020.

The Pandemic

Shares held up really well during the pandemic as shares hit a high of $50 again early in 2021, at a time when the market at large and certainly more speculative names saw big rallies. What followed was a pullback and period of stagnation with shares trading between $25 and $40 over the past year.

In February 2022, the company posted its 2021 results. Revenues rose 27% to $58 million and change, as the company missed on the original $50 million revenue target for 2020, for obvious reasons of course. While the company did see solid growth, it came at an expense (notably higher sales and marketing expenses) with an operating profit of $1.3 million in 2020 reverting to a $4.1 million loss.

The 2022 guidance looked quite promising with full year revenues seen up to $81-$83 million. Moreover, EBITDA margins are seen between 15-20% which sound better than it is as EBITDA margins came in at the middle of the range already in 2021.

Forwarding to February of this year, the company has largely delivered upon its promises with revenues up 39% to $81.0 million. The company posted an operating profit of $7.7 million, but that is better than it is as it includes a $9.2 million benefit from a negative change in the fair valuation of a contingent consideration, as otherwise an operating loss of $1.5 million was apparent.

Adjusted EBITDA of $16 million translated into margins of 20%, at the higher end of the guidance, but not sufficient to be really profitable.

Comforting is that the company sees continued growth in 2023 with revenues seen up to $94-$96 million, but more important is the midpoint of the adjusted EBITDA guidance of 25%. The five point anticipated EBITDA improvement would add about $4 million to 2022 earnings, revealing that modest operating profits would be reported in that case.

The company has used dilution to finance its growth and losses, to see a share count of 12.2 million shares representing a half a billion valuation at $40 per share in recent weeks. This results in a roughly 6 times prevailing revenue multiple, amidst largely break-even results.

What Happened?

In the time frame of a couple of days shares have fallen from $40 to $25 per share, reducing the market value of the firm by nearly $200 million to around $300 million here. This has made a huge impact on the valuation, with shares down nearly 40%. This move came in response to a news report that the city of Chicago might potentially terminate the contract with the company following a new major taking the top helmet.

That is a risk as the city of Chicago is the largest client of the company according to its most recent investor presentation , indicating that the city was responsible for $8 million in ARR, about 10% of total revenues.

And Now?

The reality is that a 40% decline in the ShotSpotter, Inc. share price in response to an anticipated client loss (responsible for 10% of sales) feels like a massive overreaction. Moreover, I am pleased with the expected margin expansion seen in 2023.

The issue which I have is that the $300 million valuation, at 3-4 times sales, is still a bit hard to justify from a fundamental point of view as ShotSpotter, Inc. continued to lose money in 2022. While spectacular margin gains are seen this year, the resulting realistic earnings are very minimal. This makes me cautious here, as I do not see the fundamental appeal based on the current valuation, even as the short term trading action feels like an overreaction.

Hence, I have put ShotSpotter, Inc. stock on my watch list, if appeal could be found, just not yet for me at this point in time.

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