SPT - Sprout Social: An Interesting Business With Some Bottom Line Work To Do

2023-08-06 06:41:34 ET

Summary

• Sprout Social aims to change the way organizations communicate with customers in the digital age.
• The company has seen impressive revenue growth but continues to post realistic losses, making it hard to see fundamental support.
• The acquisition of Tagger Media for $140 million is a significant deal for Sprout Social.

In the final days of 2019 I believed that there were modest expectations for the IPO of Sprout Social ( SPT ) . The company was looking to change the way in which organizations communicate with customers in the new digital age, and while the business has seen rapid growth, the pace of growth was coming down.

While relative sales multiples looked quite compelling, appeal had to come from sustained growth and operating leverage on the bottom line. While the company has seen continued and impressive revenue growth ever since, and modest operating leverage, the company continues to post realistic losses.

In fact, the company is not yet on the verge of being realistically profitable. This makes it hard to see fundamental support, even if shares hover near their lows.

A Recap

Sprout Social aims to change the way in which the world communicates, as the customer experience has changed due to technology and social media, requiring business to adapt to the new reality. Sprout aims to do just that and counted 23,000 customers in over 100 countries at the time of the IPO.

Since its founding in 2011, the company has operated on all large and well-known networks including names like Twitter, Facebook, Instagram, LinkedIn, YouTube and Pinterest, among many others. By providing messaging through a centralized platform, companies can create a consistent and efficient message to their customers.

The company went public at $17 per share, as 48 million shares outstanding valued the company at $814 million, although this includes a net cash position of around $150 million on a pro forma basis. The resulting $665 million operating asset valuation was attached to a business which posted $79 million in sales in 2018, a number which rose 76% on the year, although that the company posted a GAAP operating loss of $21 million.

While the pace of growth in 2018 was solid, revenues were up merely by 32% in the first three quarters of the year 2019, with revenues reported at $75 million. Operating losses rose to $21 million for the three-quarter period. Calling a 6 times sales multiple relatively compelling given the times, I had some doubts amidst slower growth and loss making operations.

The Pandemic - A Blessing

With the pandemic arriving soon after the public offering, shares have seen a big year in 2020 as shares ended the year around the $50 mark, with shares trading at $150 in the fall of 2021! Like the rest of the technology sector, shares saw a big pullback in 2022, with shares down to the $50 mark, falling to a low of $40 in April 2023. Shares rallied to the mid-fifties in July, as they have come down to $47 after an underwhelming earnings report.

The company has thrived on the back of the pandemic as a $100 million business in 2019 had grown its sales to $188 million by year-end 2021, with operating losses reported at $28 million. Revenues rose in solid fashion, up more than 35% to $254 million in 2022. GAAP operating losses nearly doubled to $52 million and while the company claimed that adjusted loss per share narrowed from $0.13 per share in 2021 to $0.05 per share in 2022, the discrepancy from GAAP earnings is entirely due to stock-based compensation expenses.

The company guided for 2023 sales to increase by 31% to $332-$333 million, with non-GAAP earnings seen coming in between $0.03 and $0.04 per share.

In May, the company posted a solid 31% increase in first quarter sales to $75 million, although that GAAP operating losses increased further to $11.9 million. The company maintained the full year sales guidance, but hiked the adjusted earnings per share guidance to $0.07-$-0.08 per share.

Early in August, Sprout announced a 29% increase in second quarter sales to $79 million as operating losses ticked up to $14.9 million, which was largely in line with the losses seen last year in this quarter. While the company posted an adjusted profit, that is entirely due to stock-based compensation expense which rose further to $16.4 million, which is adjusted for under those metrics.

The company believes that full year sales now come in around $329 million, due to the fact that it no longer caters the lower valued customers as well as it did in the past, while the company continues to see adjusted earnings around seven cents per share.

With shares down to $47 per share, the more than 55 million shares outstanding now represent a $2.5 billion equity valuation, a number which includes a net cash position of around $192 million. This still values operating assets in excess of $2.3 billion, at about 7 times sales and a non-meaningful profit multiple.

A Deal

Alongside the second quarter earnings report, Sprout announced that it has reached a $140 million cash deal to acquire Tagger Media. Tagger, which was founded in 2015, is a leading influencer marketing and social intelligence platform.

With the deal tag equivalent to about 5-6% of the company's own valuation, the bolt-on deal is substantial, certainly as it has been paid for in cash, yet few details have been announced, other than the purchase price.

Likely is that the depleting cash balances which make investors a bit nervous in connection to the deal, in combination with the slightly lower full year revenue guidance, triggering the sell-off.

A Final Word

Truth is that I am still a bit cautious here. While a 7 times sales multiple, in combination with 30% revenue growth looks reasonable, the reality is that the business continues to post large losses which were manageable (as they were caused by stock-based compensation expenses to a huge degree)

The latest cash deal makes that a substantial portion of the cash balances have been evaporated. This makes it hard to get really upbeat here from a fundamental value perspective.

That being said, the role as aggregator and key partnerships with the likes of Salesforce.com ( CRM ) are comforting, as there seems to be lasting demand for these services given the topline sales growth, with Sprout being well positioned to benefit from continued demand here.

So at these levels, near their lows, this is likely not the time to get overly bearish, but I fail to have enough conviction, or fail to see enough green shoots to become upbeat here as well.

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